Report no. 103246 SRI LANKA ENDING POVERTY AND PROMOTING SHARED PROSPERITY A Systematic Country Diagnostic Sri Lanka — Ending Poverty and Promoting Shared Prosperity | i The International Bank for Reconstruction and Development / The World Bank 1818 H Street, NW Washington, DC 20433 All rights reserved First published October 2015 Standard Disclaimer: This volume is a product of the staff of the International Bank for Reconstruction and Development/World Bank Group. The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Execu- tive Directors of the World Bank Group or the governments they represent. The World Bank Group does not guarantee the accuracy of the data included in this work. 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All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA, fax 202- 522-2422, e-mail pubrights@worldbank.org. Photos credits: Cover: Olivier Roux; Executive Summary: Picasa; Country Context: World Bank SCD; Addressing the Fiscal Challenge: World Bank SCD; Fostering Growth and Jobs for the Bottom 40 Percent: World Bank SCD; Social Inclusion for Shared Prosperity and Poverty Reduction: World Bank SCD; Sustainability: World Bank SCD; Conclusions: World Bank SCD. Cover Design and Text Layout: Duina Reyes-Bakovic SRI LANKA ENDING POVERTY AND PROMOTING SHARED PROSPERITY A Systematic Country Diagnostic Sri Lanka — Ending Poverty and Promoting Shared Prosperity | iii The Systematic Country Diagnostic: A New World Bank Group Tool for Country Engagement Under its new approach to working with its country partners, the World Bank Group (WBG) requires the preparation of a Systematic Country Diagnostic (SCD) to precede the development of Country Partnership Frameworks that guide programming. The objective of an SCD is to identify the most critical constraints and opportunities facing a country in accelerating progress toward the goals of ending extreme poverty and promoting shared prosperity in a sustainable manner. The SCD is expected to produce an objective, evidence- based, candid assessment of the main challenges facing the country, without limitation to the areas where the WBG is currently engaged. ACKNOWLEDGEMENTS We would like to thank the members of the Sri Lanka Coun- Schmitt (Program Leader), Emanuel Salinas Munoz (Pro- try Team from all World Bank Global Practices and Inter- gram Leader), and Ralph van Doorn (Sr. Economist). The national Finance Corporation (IFC), specialists from Cross team received substantial inputs from Anushka Wijesinha, Cutting Solutions Areas as well as government officials Nisha Arunatilake, Priyanka Jayawardena, Aruni Rajkrier, and other stakeholders in Sri Lanka, who have contributed Siripala Wirithamulla, and Charmaine Tillekaratne. Admin- to the preparation of this document. We are very grateful istrative support was provided by Priyantha Arachchi, Saw for the generosity exhibited in providing us with substan- Young Min, and Nelly Obias. tive inputs, knowledge and advice during the extensive stock-taking during the concept stage and in finalization The peer reviewers were: Tara Vishwanath (Lead Poverty of the diagnostic. Specialist, GPVDR), Ivan Rossignol (Chief Technical Spe- cialist, GTCDR), and Marijn Verhoeven (Lead Economist, The team was co-led by Charles Undeland (Sr. Governance GGODR) Specialist) and Gabriela Inchauste (Sr. Poverty Economist). The team received guidance from: Francoise Clottes (World The table below identifies the full list of team members Bank Country Director), Adam Sack (IFC Country Manager), that have contributed their time, effort and expertise, and Rafael Dominguez (IFC Principal Strategy Officer), Ulrich their affiliations. Global Practice/Cross-Cutting Support Area Team member(s) Agriculture Seenithamby Manoharan, Senior Rural Development Specialist Education Harsha Aturupane, Lead Education Specialist Energy & Extractives Abdulaziz Faghi, Senior Energy Specialist Environment & Natural Resources Darshani De Silva, Environmental Specialist Sebnem Sahin, Senior Environmental Economist Finance & Markets Korotoumou Ouattara, Senior Financial Economist Tisarani Rathnija Arandara, Operations Officer (IFC) Governance Jiwanka Wickremasinghe, Senior Financial Management Specialist Haider Raza, Senior Procurement Specialist Health, Nutrition & Population Kumari Vinodhani Navaratne, Senior Health Specialist Owen Smith, Senior Economist Macroeconomics & Fiscal Management Ralph van Doorn, Senior Economist Kishan Abeygunawardena, Economist Poverty David Newhouse, Senior Economist Lidia Ceriani, Extended Term Consultant Yevgeniya Savachenko, Economist Dung Thi Thuy Doan, Extended Term Consultant Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 1 Global Practice/Cross-Cutting Support Area Team member(s) Social Protection and Labor Thomas Walker, Economist Owen Smith, Senior Economist Social, Urban, Rural & Resilience Maitreyi Das, Lead Social Development Specialist Mark Roberts, Senior Urban Specialist Zhiyu Jerry Chen, Urban Specialist Marc Forni, Sr. DRM Specialist Suranga Kahandawa, DRM Specialist Lisa Schmidt, Extended Term Consultant Ezgi Canpolat, Consultant Trade & Competitiveness Michael Engman, Senior Economist Sriyani M. Hulugalle, Senior Economist Lohitha Karunasekera, Private Sector Development Specialist Massimiliano Cali, Senior Trade Economist Shaun Mann, Senior Investment Policy Officer (IFC) Mohamed Hafiz Zainudeen, Operations Analyst (SACSL) Transport & ICT Amali Rajapaksa, Senior Infrastructure Specialist Seda Pahlavooni, Senior Infrastructure Specialist Kamaljith Dorabawila, Principal Investment Officer (IFC) Water Samantha Wijesundera, Water & Sanitation Specialist Climate Change Zhuo Cheng, Carbon Finance Specialist Gender Mohamed Ghani Razaak, Senior Social Development Specialist 2 TABLE OF CONTENTS Acknowledgements...................................................................................................................................................................1 Abbreviations and Acronyms..................................................................................................................................................9 I. Executive Summary.................................................................................................... 10 The Fiscal Challenge................................................................................................................................................................ 12 The Challenge of Promoting More and Better Jobs for the Bottom 40 Percent................................................ 12 Inward versus Outward Orientation of the Economy............................................................................................. 13 The Relationship between the Public Sector and Private Sector ...................................................................... 14 Social Inclusion Challenges.................................................................................................................................................. 15 The Cross-Cutting Governance Challenge ..................................................................................................................... 16 Sustainability Challenges...................................................................................................................................................... 17 Conclusions ............................................................................................................................................................................... 17 II. Country Context........................................................................................................ 20 A. Political and Social Context ........................................................................................................................................... 21 B. Poverty and Shared Prosperity .................................................................................................................................... 22 C. Understanding Changes in Poverty............................................................................................................................ 28 Structural Transformation .............................................................................................................................................. 30 Agglomeration Effects..................................................................................................................................................... 31 Increases in Aggregate Demand, including Government Infrastructure Projects..................................... 32 Increased Commodity Prices......................................................................................................................................... 32 D. Macroeconomic Challenges to Poverty Reduction and Shared Prosperity ................................................. 34 E. Identifying Drivers and Constraints to Poverty Reduction and Shared Prosperity ................................... 38 III. Addressing the Fiscal Challenge............................................................................. 39 A. Low and Declining Fiscal Revenues............................................................................................................................ 41 B. Expenditure Pressures...................................................................................................................................................... 45 C. Insufficient Spending in Key Areas.............................................................................................................................. 46 D. Inefficiency in Social Transfers...................................................................................................................................... 49 E. Large Public Sector........................................................................................................................................................... 51 F. Improving Public Expenditure Management.......................................................................................................... 51 G. Medium-Term Fiscal Sustainability.............................................................................................................................. 53 H. Priorities in Addressing the Fiscal Challenge........................................................................................................... 53 IV. Fostering Growth and Jobs for the Bottom 40 Percent......................................... 55 A. Ample Opportunities for Success ............................................................................................................................... 56 B. Inward versus Outward Orientation of Economic Activity................................................................................. 58 Trade and Industrial Policies.......................................................................................................................................... 60 Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 3 Attracting and Retaining Efficiency-Enhancing Foreign Direct Investment (FDI) ..................................... 63 Ensuring Human Capital and Skills for Competitiveness.................................................................................... 65 Innovation Policies............................................................................................................................................................ 71 C. The Relationship between the Public Sector and Private Sector..................................................................... 73 Public Sector Performance as a Regulator................................................................................................................ 73 Regulatory Environment and Informality................................................................................................................. 77 The State as Market Participant.................................................................................................................................... 81 The Public Sector as Employer...................................................................................................................................... 85 Interconnectedness of Public and Private Sectors................................................................................................ 88 D. Priorities for Fostering More and Better Jobs for the Bottom 40 Percent..................................................... 88 V. Social Inclusion for Shared Prosperity and Poverty Reduction............................. 90 A. Inclusion across Space .................................................................................................................................................... 91 Spatial Concentration of Poverty................................................................................................................................. 91 Conflict Affected Areas.................................................................................................................................................... 93 The Estate Sector .............................................................................................................................................................. 95 Moneragala........................................................................................................................................................................102 B. Inclusion of Ethnic Communities...............................................................................................................................103 Internally Displaced Persons and Returnees: An Additional Axis of Exclusion ........................................106 C. Gender Inclusion .............................................................................................................................................................107 Low Female Labor Force Participation ....................................................................................................................107 Gender Wage Gap and Occupational Segregation ............................................................................................109 Female Labor Migrants and Their Families: The Inclusion Challenges of Migration...............................110 Women in Leadership Roles........................................................................................................................................111 D. Priorities on Inclusion.....................................................................................................................................................112 VI. Sustainability.......................................................................................................... 113 A. Social Risks to Sustainability........................................................................................................................................114 Peace and Security..........................................................................................................................................................114 Other Social Risks.............................................................................................................................................................115 Institutional Change.......................................................................................................................................................116 B. Economic Risks to Sustainability................................................................................................................................116 External Risks.....................................................................................................................................................................116 Long-Term Risks to Fiscal Sustainability..................................................................................................................117 C. Environmental Risks to Sustainability .....................................................................................................................119 Climate Change ...............................................................................................................................................................121 D. Priorities on Sustainability............................................................................................................................................122 VII. Conclusions........................................................................................................... 124 Identifying a Path Forward ..........................................................................................................................................125 Priority Areas of Focus to End Poverty and Promote Shared Prosperity in a Sustainable Way............125 4 Cross-Cutting Challenges.............................................................................................................................................128 Synergies.............................................................................................................................................................................129 References.................................................................................................................................................................................131 APPENDIXES................................................................................................................. 137 Appendix 1 Performance on the Millennium Development Goals, interNational comparison.........138 Appendix 1.2 Poverty Indicators for Sri Lanka.........................................................................................................140 Appendix 1.3 Sri Lanka. Characteristics of the Poor..............................................................................................141 Appendix 1.4 Methodology...........................................................................................................................................142 Appendix 2.1 Infrastructure ..........................................................................................................................................150 Appendix 2.2 Opportunities and Obstacles in Access to Finance....................................................................154 Map of Sri Lanka......................................................................................................................................................................156 List of Figures Figure 1.1 Balancing between inward vs. outward orientation and public vs. private sector driven development; Sri Lanka 1965-2013.......................................................................................... 13 Figure 2.1 GDP growth and inflation over time and relative to other MICs.................................................. 23 Figure 2.2 Income and multidimensional poverty measures have improved............................................. 24 Figure 2.3 Extreme poverty-growth semi-elasticity .............................................................................................. 25 Figure 2.4 Growth incidence curves: per capita consumption growth.......................................................... 26 Figure 2.5 Poverty headcount rates, by ethnicity and religion (national poverty line)............................ 27 Figure 2.6 Poverty headcount rates, 2012/13 (by division)................................................................................. 27 Figure 2.7 Distribution of the poor, 2012/13 (absolute number of poor)...................................................... 27 Figure 2.8 Net contributions to poverty reduction, 2002-2012/13.................................................................. 28 Figure 2.9 Most remittances in absolute amounts go to the top of the distribution (percent of total household consumption).......................................................................................... 29 Figure 2.10 Increased labor demand is reflected in wage and employment growth ................................. 29 Figure 2.11 Sectoral value added and employment growth................................................................................ 30 Figure 2.12 Sectoral productivity 2002-2012............................................................................................................. 31 Figure 2.13 Night lights image of Sri lanka, 1975- 2014......................................................................................... 31 Figure 2.14 Agglomeration and growth....................................................................................................................... 32 Figure 2.15 Growth in aggregate demand.................................................................................................................. 33 Figure 2.16 Poverty rates fell most rapidly among workers in agriculture...................................................... 33 Figure 2.17 Wages by sector............................................................................................................................................. 34 Figure 2.18 Sectoral growth patterns............................................................................................................................ 35 Figure 2.19 Steady decline in trade................................................................................................................................ 35 Figure 2.20 Product space comparison: Sri Lanka vs Thailand in 1980 & 2009.............................................. 36 Figure 2.21 Steady decline in trade................................................................................................................................ 37 Figure 2.22 Fiscal performance of Sri Lanka............................................................................................................... 37 Figure 3.1 Revenue and expenditure trends............................................................................................................ 40 Figure 3.2 Revenue performance of Sri Lanka......................................................................................................... 41 Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 5 Figure 3.3 Tax composition in South Asia................................................................................................................. 42 Figure 3.4 Trend in tax-to-GDP and drivers of changes....................................................................................... 43 Figure 3.5 Public Expensiture and Financial Accountability (PEFA) performance on tax-related indicators................................................................................................................................... 44 Figure 3.6. Fiscal indicators.............................................................................................................................................. 46 Figure 3.7 Government guarantees............................................................................................................................. 46 Figure 3.8 Health and education expenditures (share of GDP)......................................................................... 47 Figure 3.9 Social protection expenditures are insufficient and inefficient (share of GDP)...................... 48 Figure 3.10 Usage patterns of vehicles, 1960-2030.................................................................................................. 48 Figure 3.11 Incidence of social benefits (percentage of benefits accruing to each quintile)................... 49 Figure 3.12 Age-gender pyramid.................................................................................................................................... 50 Figure 4.1 Annual tourist arrivals, 1967-2013.......................................................................................................... 57 Figure 4.2 Balancing between inward vs. outward orientation and public vs. private sector driven development; Sri Lanka 1965-2013.......................................................................................... 58 Figure 4.3 Obstacles to global competitiveness, rankings.................................................................................. 59 Figure 4.4 Exports per capita are low and Labor-intensive................................................................................. 59 Figure 4.5 Sri Lanka’s exports by product category in 1990 vs 2013............................................................... 60 Figure 4.6 Nominal trade protection, 1982–january 2011 (percent)............................................................... 61 Figure 4.7 Net Inflows and composition of FDI....................................................................................................... 63 Figure 4.8 Completed O-levels by age group.......................................................................................................... 66 Figure 4.9 Learning outcomes....................................................................................................................................... 66 Figure 4.10 Increasing demand for workers with better skills............................................................................. 67 Figure 4.11 Sri Lanka has a small stock of highly skilled workers, with trends that are not encouraging.................................................................................................................................................... 68 Figure 4.12 Factors that inform the selection of investment destinations...................................................... 69 Figure 4.13 Education and training mismatches....................................................................................................... 69 Figure 4.14 Inadequate skills lead to low returns to education........................................................................... 70 Figure 4.15 R&D expenditure (percent of GDP) ........................................................................................................ 71 Figure 4.16 Proportion of firms using technology licensed from foreign companies (percent).............. 72 Figure 4.17 Applications for trademarks and patents per US$100 billion, 2013 (total count, by applicants origin)..................................................................................................................................... 73 Figure 4.18 Comparison of rankings, Doing Business 2015.................................................................................. 74 Figure 4.19 Percent of firms identifying business licensing and permits as a major constraint.............. 75 Figure 4.20 Logistics performance index scores (2010-2014).............................................................................. 76 Figure 4.21 Duration of procedures for imports/exports....................................................................................... 76 Figure 4.22 Regulatory compliance prompt entrepreneurs to operate informally...................................... 78 Figure 4.23 Distribution of industries by number of establishments and persons engaged................... 78 Figure 4.24 Non agricultural employment.................................................................................................................. 79 Figure 4.25 Access to finance difficulties driven by high collateral requirements........................................ 80 Figure 4.26 The composition of wage employment has shifted towards the public sector (share of total wage workers).................................................................................................................... 85 6 Figure 4.27 Public and formal sector workers earn more than their private sector counterparts.................................................................................................................................................... 86 Figure 4.28 Workers are queuing for public sector jobs......................................................................................... 86 Figure 5.1 Spatial location of overall population, poverty and the bottom 40 percent .......................... 92 Figure 5.2 Share of national poor and vulnerable within 30km of all agglomerations............................ 92 Figure 5.3 Poverty headcount rate in Sri Lanka....................................................................................................... 93 Figure 5.4 The North and East have weak links to the labor market............................................................... 94 Figure 5.5 Most of the reduction in estate poverty happened during 2006-2009..................................... 96 Figure 5.7 Real wage increases have been largest in the estate sector.......................................................... 96 Figure 5.6 Higher tea prices led to larger profit to the tea industry................................................................ 96 Figure 5.8 Poverty headcount and poverty gap by location, 2012 /2013..................................................... 97 Figure 5.9 Nutrition indicators....................................................................................................................................... 97 Figure 5.10 Housing conditions in estate sector (percentage of households with access)....................... 98 Figure 5.11 Access to health and education services (average time to travel, in minutes)....................... 98 Figure 5.12 Educational levels and enrollment.......................................................................................................... 99 Figure 5.13 The youth are leaving the estate sector and the share of agricultural workers is in decline........................................................................................................................................................100 Figure 5.14 Labor force participation and unemployment rates for youth, ages 15-24...........................100 Figure 5.15 Moneragala labor force characteristics and travel times to facilities.......................................102 Figure 5.16 Sri Lankan Tamils and Moors have higher levels of poverty........................................................103 Figure 5.17 Access to services and educational attainment by ethnicity......................................................104 Figure 5.18 Share of households owning some land, by ethnicity...................................................................105 Figure 5.19 Likelihood of activity relative to public sector employment and Sinhalese counterpart (individuals age 15 and over).........................................................................................105 Figure 5.20 Household debt to money lenders by province..............................................................................106 Figure 5.21 Female labor force participation............................................................................................................108 Figure 5.22 Understanding the gender wage gap.................................................................................................109 Figure 5.23 Female labor force participation by location and ethnicity, 2012.............................................110 Figure 5.24 Female representation in parliament...................................................................................................111 Figure 6.1 Elderly dependency ratios, for different demographic scenarios .............................................117 Figure 6.2 Aging and social expenditures in international perspective.......................................................118 Figure 6.3 Population projections in Sri Lanka......................................................................................................118 Figure 6.4 Impacts of a 1-meter sea level rise .......................................................................................................122 Figure A1 Diagnostic framework...............................................................................................................................142 Figure A2 Digging deeper............................................................................................................................................143 Figure A3 Access to infrastructure.............................................................................................................................150 Figure A5 Electricity generation of grid power plants, 1976-2012................................................................151 Figure A4 Assessment of overall infrastructure by firms...................................................................................151 Figure A7 Projected growth of electricity generation, 2013-2032................................................................152 Figure A6 Share of households with access to electricity.................................................................................152 Figure A8 Mobile telephony and internet penetration.....................................................................................153 Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 7 Lis of Boxes Box 4.1 Tourism on the rise but constrained by capacity...................................................................................... 57 Box 4.2 Global experience in attracting and retaining FDI: infrastructure and incentives are not major factors................................................................................................................................................... 64 Box 4.3 Defining State-Owned Enterprises (SOEs)................................................................................................... 82 Box 4.4 State intervention in agriculture..................................................................................................................... 87 Box 5.1 Female-Headed households in the northern and eastern provinces................................................ 94 Box 5.2 Inclusion of ex-combatants.............................................................................................................................. 95 Box 5.3 Gender-based violence: one of the most extreme forms of exclusion...........................................101 Box 7.1 Approach to prioritization...............................................................................................................................126 List of Tables Table 1.1 Priorities to end poverty and promote shared prosperity in a sustainable................................ 19 Table 2.1 Poverty and inequality trends .................................................................................................................... 24 Table 3.1 Paying Taxes – Compliance of Corporate Income Tax ........................................................................ 44 Table 3.2 Tax rates (2013) ................................................................................................................................................ 45 Table 3.3 VAT compared with other countries.......................................................................................................... 45 Table B1 FDI Flows: the hypothetical effect of removing FDI restrictions..................................................... 65 Table 4.1 Technology and development*.................................................................................................................. 71 Table 4.2 Sector wise performance of asset base of state owned business enterprises........................... 83 Table 5.1 Poverty in post-conflict areas is high ....................................................................................................... 93 Table 6.1 Impact of climate change on rice yield in Sri Lanka..........................................................................121 Table 7.1 Determination of priorities........................................................................................................................ 127 8 ABBREVIATIONS AND ACRONYMS ADB Asian Development Bank MSME Micro, Small and Medium Enterprise ASYCUDA Automated System for Customs Data NBT Nation Building Tax BOI Board of Investment NWSDB National Water Supply Drainage Board CCPI Colombo Consumer Price Index PA Protected Area CEB Ceylon Electricity Board PEFA Public Expenditure and Fiscal DCS Department of Census and Statistics Accountability DHS Demographic and Health Survey PERC Public Enterprise Reform Commission EPD External Degree Programs PPP Public-Private Partnership EPZ Export Processing Zone PSC Public Service Commission EU European Union R&D Research and Development FDI Foreign Direct Investment RWS Rural Water Supply G.C.E. A/L General Certificate of Education – SAR South Asia Region Advanced Level SCD Systematic Country Diagnostic GDP Gross Domestic Product SEMA Strategic Enterprise Management GIC Growth Incidence Curve Agency HIES Household Income and Expenditure SITC Standard International Trade Survey Classification IDP Internally Displaced Person SME Small and Medium Enterprise IFC International Finance Corporation SRL Social Responsibility Levy ILO International Labor Organization SOBE State-Owned Business Enterprise IMF International Monetary Fund SOE State-Owned Enterprise JMP Joint Monitoring Programme TEWA Termination of Employment of Workmen Act LDO Land Development Ordinance TIMSS Trends in International Mathematics and LIC Lower Income Country Science Study LLRC Commission of Inquiry on Lessons TFP Total Factor Productivity Learned and Reconciliation UNDP United Nations Development LMIC Lower Middle Income Country Programme LTTE Liberation Tigers of Tamil Eelam VAT Value Added Tax MDGs Millennium Development Goals WBG World Bank Group MoF Ministry of Finance WGI World Governance Indicator MIC Middle Income Country Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 9 I. EXECUTIVE SUMMARY 10 | I. Executive Summary 1. Sri Lanka is in many respects a development suc- 4. The country is at an important economic and po- cess story. With economic growth averaging more than 7 litical crossroads as it faces these challenges. Sri Lanka’s percent a year over the past five years on top of an aver- real gross domestic product (GDP) grew by 43 percent from age growth of 6 percent the preceding five years, Sri Lanka 2009 to 2014, with the top four sectors (accounting for half has made notable strides towards the goals of ending ex- of total growth) being all non-tradable sectors: construc- treme poverty and promoting shared prosperity (the “twin tion, transport, domestic trade and banking, insurance and goals”). The national poverty headcount rate declined real estate. A substantial portion of this growth was driven from 22.7 to 6.7 percent between 2002 and 2012/13, while by public investment to re- consumption per capita of the bottom 40 percent grew at 3.3 percent a year, compared to 2.8 percent for the total build after the end of its 30- year internal conflict in 2009. Poverty dropped by population. Other human development indicators are also These sectors, as well as the over two-thirds from impressive by regional and lower middle-income country economic boost at the end 2002 to 2012/13 standards. Sri Lanka has also succeeded in ending decades of the conflict, are not likely of internal conflict in 2009 and steps have been taken to- to be sustainable sources of wards reconciliation. growth in the long run. In addition to the need to foster new sources of growth, Sri Lanka is in the process of major 2. Increases in labor incomes account for most of governance reforms following the election of a new gov- the reduction in poverty over the last 10 years. Be- ernment in early 2015. The Constitution has been amend- tween 2002 and 2012/13, most of the reduction in pov- ed to overhaul the structure of government by reducing erty was due to increased earnings, as opposed to higher the power of the presidency and providing for more inter- employment or higher transfers. Although it is hard to be nal checks and accountability mechanisms. There is also certain, increases in earnings are associated with: (i) a slow now a constitutional guarantee of citizens’ right to infor- structural transformation away from agriculture and into mation. At the same time, while reforms to promote trans- industry and services that led to productivity increases; (ii) parency and accountability in government should lead to agglomeration around key urban areas that supported this better performance, a political settlement around the new structural transformation; (iii) domestic-driven growth, in- governance structure will need to emerge. cluding public-sector investment that led to increases in labor demand, particularly in industry and services; and 5. Bearing in mind the challenges to Sri Lanka’s fur- (iv) a commodity boom that led to higher labor earnings ther development, this diagnostic consists of a system- for agricultural workers in the context of lower agricultural atic and detailed review of potential factors impacting employment. progress on the twin goals. In line with the World Bank Group’s new approach to 3. However, important challenges lie ahead that country engagements, this may hinder further progress on poverty reduction and report aims to identify the Although Sri shared prosperity. Despite the low levels of extreme pov- most critical constraints and Lanka has excelled erty, roughly one quarter of Sri Lankans are nearly poor, as achievement of the twin in overcoming opportunities to advancing defined by living above the official poverty line (equiva- lent to about $1.50 per day in 2005 purchasing power par- goals. In order to organize development ity, PPP, terms) but below $2.50 per day in 2005 PPP terms. and discipline the analysis, challenges typical of The living standards of the near poor are closer to those of the report uses a framework the poor than those living above $2.50 per day. Moreover, that combines the Hausman, a low income country, Sri Lanka’s aspirations as a middle-income country (MIC) Rodrik and Velasco (2005) it must adjust to face will differ from those of a successfully developing low-in- growth diagnostic and the come country emerging out of conflict. Although Sri Lan- Bussolo and Lopez-Calva new demands typical ka has excelled in overcoming human development chal- (2014) asset-based approach of a middle income lenges typical of a low-income country, its service delivery systems in education, health, and other areas must now to identify a universe of 22 potential areas that may country adjust to face new and changing demands typical of a MIC. constrain or drive progress Imperatives to improve social protection programs will in- towards the twin goals. Sri Lanka’s performance in each crease owing to an aging population that has passed its area was assessed for its relative impact on achieving the demographic peak. Finally, given increasing affluence and twin goals. This systematic analysis was then presented in information, there will be higher expectations of the state set of consultations with multiple stakeholders, including to perform in order to facilitate growth, provide higher lev- government, academia, think tanks, the private sector, civ- el of services, and demonstrate increasing responsiveness il society organizations, and international organizations to to a more demanding citizenry. validate the findings, determine the relative importance of Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 11 issues identified in each of the 22 areas and identify knowl- transfers, and interest payments, have accounted for 60 edge gaps. These findings were weighted against crite- percent of expenditure in recent years. Moreover, wage ria of: (i) the potential impact on ending poverty and on pressures have been rising due to a 57 percent increase promoting shared prosperity; (ii) the degree to which ad- in the number of public servants in the past 10 years. This dressing these constraints would have complementarities has yielded a situation where public servants account for across different domains; (iii) the strength of the evidence 13 percent of the labor force, comparable to the OECD av- base behind the impact; (iv) the time horizon of impacts; erage of 15 percent in 2011. At the same time, increases and (v) whether addressing the constraint is a precondi- in recurrent expenditures in early 2015, particularly a raise tion to unlocking wider potential. This process yielded in allowances to public servants, is to be financed by one- consensus that the key priorities for sustaining progress time taxes, leaving very little room to maneuver. A strong in ending poverty and promoting shared prosperity are to commitment to fiscal consolidation in the face of these address the country’s fiscal, competitiveness and inclusion pressures has led to Sri Lanka having extremely low levels challenges, as well as cross-cutting governance and sus- of public spending on education, health, and social pro- tainability challenges. tection as a percentage of GDP. Going forward, continued commitment to fiscal consolidation is critical to ensure macroeconomic stability, but this will require long-term The Fiscal Challenge improvements in revenues. 6. Low and declining revenues critically impact Sri Lanka’s fiscal position. Sri Lanka now has one of the The Challenge of Promoting More lowest tax revenue-to-GDP ratios in the world, reflecting a decline from 24.2 percent in 1978 to 10.7 percent in 2014. and Better Jobs for the Bottom 40 The major causes of this decline are the low increase in the Percent number of taxpayers, reductions in statutory rates with- out commensurate efforts 8. Sri Lanka has a number of advantages that can Sri Lanka has one to expand the tax base, inef- contribute to inclusive growth. Given its relatively small ficiencies in administration domestic market, Sri Lanka will need to look outward to of the lowest tax and numerous exemptions. fulfill its ambitions to become a prosperous and competi- revenue-to-GDP ratios In particular, since the in- tive middle-income country. As such, the country has im- in the world troduction of a value added tax (VAT) in 2002, successive portant strengths, such as overall strong human capital and a reliable infrastructure base, particularly when com- changes in the tax regime pared to other South Asian countries. Sri Lanka also enjoys have led to over 500 types of exemptions for a wide variety an enviable location in a fast-growing region along a major of goods. There are also over 40 broad types of exemptions trade route, opening oppor- on corporate and personal income tax depending on the source of income and the type of taxpayer. Administration tunities to serve as a regional trading hub. Moreover, Sri Sri Lanka has an is complicated by lack of coordination among entities col- Lanka’s boasts unique natu- enviable location and lecting revenue as well as the Board of Investment, which ral assets, with a temperate unique natural assets provides incentives. No tax expenditure analysis is con- climate, diverse topography, ducted before or after the introduction of incentives. and unique historical assets, giving it a strong basis for tourism. At the same time, the 7. Low tax revenues combined with an expenditure country has a track record of developing globally compet- profile that is largely non-discretionary has led to a itive companies, particularly in niches of the apparel and lean, rigid budget with little room for critical develop- information technology (IT) sectors. ment spending. Sri Lanka’s overall revenues and expendi- tures are among the lowest in the region as a percentage 9. To capitalize on its advantages Sri Lanka will of GDP. Fiscal consolidation and relative prioritization of need to find an effective balance along two axes: (i) in- public investment in capital infrastructure following the ward vs. outward orientation of the economy; and (ii) conflict have squeezed spending on other public goods, the respective roles of the public and private sectors including health, education and social protection, which (Figure 1.1). The country’s world market share has fallen to are currently below levels in other regional and emerging levels last seen in the 1980s, with a steady decline in com- market comparators. Fiscal consolidation combined with modity exports and an export basket that has remained declining revenues has made the budget rigid, leaving largely unchanged in a context of rising production costs little fiscal space for the government to maneuver. Diffi- and weakening demand due to slow growth in some of its cult-to-reduce items, such as public service remuneration, main markets (Europe and the Middle East). At the same 12 | I. Executive Summary Figure 1.1 Balancing between inward vs. outward orientation and public vs. of protection on final products than on inputs used in their production lead to an anti-export private sector driven development; Sri Lanka 1965-2013 bias, since producers have strong incentive to sell goods domestically even though their do- 95% mestic costs are higher than their opportunity (Private as percent of total Fixed Capital Formation) 90% 2000 costs through trade. This is particularly worry- ing for the agricultural sector, where high pro- Public Sector Led <---------------> Private Sector 85% Driver of Economic Development 2013 tection of import-competing crops along with 80% 1980 fertilizer subsidies have created strong disin- 75% centives for crop and export diversification. 1970 Incentives are structured to expand produc- Led 70% tion of import-competing crops (rice, maize) 65% and discourage the production of exportables 60% through the introduction of high export taxes 55% (‘cesses’) on raw materials such as tea, rubber, 50% cinnamon, coconut and spices, with the no- 40% 50% 60% 70% 80% 90% 100% tion that this would increase value addition of Inward <--------------------------------------------------> Outward exports. Revenues from cesses were supposed Orientation of the Economy to be then invested in research and develop- (Exports + imports as a percent of GDP) ment for the corresponding sectors to encour- age value addition, yet this has not been im- Source: World Development Indicators. All data refer to Sri Lanka plemented. 11. Foreign direct investment, a foun- time, the economy has shifted towards a public-sector led dation for economic diversification, has been disap- model, as public investment to rebuild following the end pointing despite numerous fiscal incentives. FDI re- of conflict was responsible for much of the large growth in mains below 2 percent of GDP five years after the end of construction as well as transport over the last decade. armed conflict, which is low relative to much higher levels of FDI in other MICs such as Vietnam or Cambodia. While Inward versus Outward Orientation of the FDI can enhance access of producers to global production Economy networks and facilitate the development of new activi- ties within existing value chains, FDI inflows to Sri Lanka 10. While Sri Lanka’s in- have been largely focused on infrastructure (inclusive of dustrial policy has been real estate development), with a relatively small propor- The degree of broadly market-orient- tion reaching sectors of the economy that are associated outward orientation ed since liberalization in with global networks of production. Although conclusive has wavered in the the 1970s, the degree of outward orientation has data is not available, the benefits from incentives in terms of attraction and retention of productivity-enhancing FDI past decade wavered in the past de- may not outweigh the costs involved in fiscal losses and cade. Two earlier rounds potential disruption of market dynamics (through, among of economic liberalization other things, the creation of an unleveled playing field). introduced a series of reforms towards deregulating the Global experience suggests that the most important ways economy, accompanied by a strong focus on export ori- to ensure both domestic and foreign investment include entation and foreign direct investment (FDI) promotion. measures to improve the enabling environment, including The last decade has seen a noticeable shift towards pro- through a skilled workforce and adequate innovation poli- tectionism. The introduction of para-tariffs has effectively cies that form the basis of a competitive economy. doubled the protection rates, making the present import regime one of the most 12. Despite past achievements, the quality of gener- complex and protection- al education lags behind higher middle-income coun- The import regime ist in the world. Moreover, tries and firms have difficulty accessing the skills they need. Although human development indicators are ahead is one of the most the para-tariffs’ dispersion of regional peers, the quality of education, as measured protectionist in the leads to prices that distort production and consump- by periodic internationally comparable tests, lags be- world tion patterns. Higher rates hind that of higher middle-income countries, particularly in language and numeracy skills. Sri Lanka also lacks the Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 13 kind of vocational and technical skills in its workforce that requires that firms with 15 or more employees justify are increasingly in demand, reflecting constraints on the layoffs and provide generous severance pay to displaced quality and relevance of higher education and research. workers, with smaller firms being exempted. These sever- For instance, over 75 per- ance payments are expensive relative to regional and mid- Sri Lanka lacks cent of employers expect a dle-income peers. Finally, the legal framework prevents women from taking up night work or part-time work in the high-skilled worker to know vocational and English and have computer growing service sector while the laws governing maternity technical skills that skills, but only 20 percent benefits make employers bear the entire cost, potentially deterring employers from hiring women. are increasingly in of Sri Lankans are fluent in English and only 15 percent demand can use computers. More 15. Regulatory com- pliance burdens prompt Regulatory generally, there are poor entrepreneurs to operate informally, which under- compliance linkages between what the private sector needs in order mines competition. Most burdens prompt to innovate and research and development institutions that could meet these needs. This is particularly acute in agriculture where there is limited distribution of new tech- business establishments in Sri Lanka are small and hence entrepreneurs to nologies critical for modern farming. do not benefit from econ- operate informally, omies of scale. Moreover, an important obstacle The Relationship between the Public Sector and side-by-side operations of Private Sector informal and formal firms in a to growth and market lead to unfair practic- competitiveness 13. The government’s performance as regulator and es and market inefficiencies. facilitator of economic activity has improved in recent Unfair competition from in- years, though significant shortcomings remain. Given formal players is viewed as the single most important ob- fiscal constraints, sustained growth will need to be driven stacle to the growth and competitiveness of established by the private sector, which, in turn, calls for government firms. At the same time, informal firms generally have no regulation conducive to business. Among areas of regula- access to financial services, government contracts, and es- tion, systems for registration of property rights and land- sential licenses and permits. use regimes that introduce limitations and lead to frag- 16. Although successive policy regimes have intro- mentation of land parcels duced numerous programs aimed at supporting the Property rights and are important constraints to businesses. Land ownership small and medium-sized enterprise (SME) sector, firms land-use regimes are issues are the most com- in this sector face multiple constraints, particularly access to finance and technology. Financing issues are important constraints mon reason cited by infor- driven by weaknesses of the firms to put forward bankable mal firms for not registering. projects as well as failures in SME banking which relies on Moreover, the predictability asset-based financing with little flexibility to provide proj- of state regulation with regard to property rights has prov- ect-based finance. SMEs also find it difficult to access tech- en to be an issue, with particular harm caused by the “Re- nology to upgrade their businesses. Reducing the cost of vival of Underperforming Enterprises and Underutilized operating a business along with stronger enforcement can Assets Act”, which expropriated 37 enterprises in sectors help to reduce informality, reduce uncompetitive practic- like hotels, mixed-property development and the sugar es, and, by extension, create an environment more condu- industry. Licenses and permits are also an obstacle, partic- cive to investment in productivity-enhancing activities. ularly in the Northern Province. Finally, policy-induced bar- riers consisting of regulatory and institutional bottlenecks 17. The proliferation of small firms and informal em- account for nearly 70 percent of the total time spent on ployment has important consequences for the ability exporting or importing goods. of the bottom 40 percent to share in the growth pro- cess. Most of the increase in non-agricultural employment 14. Similarly, labor market regulations appear to between 2002 and 2012 was in self-employed non-farm be constraining the growth of employment. Although workers. Moreover, the decline in agricultural employment labor market regulations aim to provide job security to coincided with an increase in workers employed in estab- formal sector workers, since these represent only about 15 lishments with no regular employees. By 2012, 74 percent percent of the workforce, they have resulted in creating a of unskilled workers (those with less than a primary educa- deep divide between formal and informal workers. Sri Lan- tion) had only temporary or casual wage employment, up ka’s Termination of Employment of Workmen Act (TEWA) 14 | I. Executive Summary from 70 percent in 2006, suggesting that these workers are a more level playing field will encounter resistance from increasingly working under precarious conditions. Wages vested interests. of temporary workers are on average 33 percent lower than wages of permanent workers; one-third of which cannot be explained by differences in the job or individ- Social Inclusion Challenges ual characteristics, suggesting that workers would choose more stable reliable jobs if they could. 20. The highest numbers of people living in poverty and the bottom 40 percent are located within multi- 18. Beyond carrying out regulatory functions, the city agglomeration areas. At the same time, urbaniza- state itself is a major par- tion in Sri Lanka has been a strong driver of growth and that trend will continue. Streamlining urban management A large public ticipant in the market through its large state- structures and improving sector impacts owned enterprise (SOE) their capacity to ensure Urbanization can competitiveness in sector and public service, they have the administrative powers to deliver functional facilitate inclusion which in turn has impact- a number of sectors ed competitiveness in a urban services and conduct and labor market number of sectors and integrated, strategic planning (including land use plan- labor market dynamics. ning and transport planning) will provide local authorities dynamics SOEs have a significant mar- with the opportunity to respond to both present and fu- ket share in many sectors, ture needs. Improved connectivity across the country will including areas where there is not a strong apparent ra- further assist in raising the economic potential located tionale for public intervention. This is most striking in the outside the Kandy-Colombo-Galle agglomeration, as well finance sector, where major SOEs make up close to half of as improving growth drivers within those districts. Further the market. At the same time, there is a weak framework analysis on the constraints to participation of the bot- for public-private partnerships and relatively few cases of tom 40 percent in further agglomeration and spreading PPPs; infrastructure development over the past 10 years economic activity will be important for assessing what is has been driven by direct public spending. Finally, the needed to have urbanization facilitate inclusion. state plays an outsized role as an employer. There is strong demand for public-sector jobs as public-sector workers 21. The poor in more isolated regions of the country enjoy the advantages of formal employment and other represent a different challenge. There are high rates of benefits such as a pension. Moreover, the evidence sug- poverty in the Northern and gests that there is a salary premium for public-sector work- Eastern Provinces, the cen- ers and that this premium has grown between 2006 and ter where the estate sector There are high (plantation-based agricul- ture) is concentrated, and rates of poverty in 2012. Workers, particularly educated women, are queuing for public-sector employment. Moneragala in the south- the Northern and 19. Finally, there has been a high degree of intercon- nectedness between the state and some segments of east. Poverty rates are high- est in portions of the North- Eastern Provinces, the private sector that motivates intervention by the ern and Eastern provinces, the estate sector, and government. The variation in tax and customs incen- which were most affected Moneragala tives reflects government policy but also contains specific by the internal conflict. The benefits for specific sectors, many of which have a limit- high poverty headcount rates in these regions are asso- ed number of major actors. In addition, there are several ciated with weak links to the labor market, particularly high-profile cases of movement of senior officials between among the youth and educated women. People with phys- public and private sectors as there is no developed frame- ical disabilities and psychological problems due to conflict, work for handling conflicts of interest to separate pub- in particular ex-combatants and widows, are particularly lic-sector work from private-sector interests. Given that vulnerable to exclusion. there are frequent instances of state regulatory help to a given sector it follows that private-sector entities would 22. Poverty measured by consumption has dropped seek to maintain or expand privileges, reinforcing the lev- significantly among estate workers, but non-monetary el of regulatory intervention into the economy. These cir- measures of poverty and vulnerability remain high. cumstances also suggest that many private-sector entities Estate workers continue to be largely dependent on the would have to adjust considerably were Sri Lanka to open estate’s management for many basic needs, particularly its markets to a greater extent. Changing the state’s role housing. While poverty in the estate sector fell markedly in as an employer, market actor and regulator to provide for the past decade, poverty rates continue to be higher com- Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 15 pared to both urban and rural sectors, pointing to contin- toilet within their unit and access to electricity. Similarly, ued vulnerability. This is particularly evident when looking educational attainment is lower for the ethnic minority at health and nutrition indicators. Estates have the highest workforce, and rates of ownership of land are also uneven maternal mortality rates in the country, and both estate among the country’s ethnic communities. In terms of labor women as well as children suffer from high rates of mal- market opportunities, labor force participation is low and nutrition that are double national averages. Estate-sector unemployment is high for Sri Lankan Tamils and Moors. households are less likely to have drinking water, sanitary However, when focusing outside of the post-conflict re- facilities or electricity within their households. Moreover, gions, both Sri Lankan and Indian Tamils have higher labor access to services and the quality of services in the estates force participation and employment rates relative to their is comparatively low. Poor outcomes in education impede Sinhalese counterparts. This suggests that different rates the ability of the estate population to participate in Sri of participation are mostly determined by differences in Lankan society. The youth are increasingly leaving the es- employment opportunities. The conflict-affected areas tate sector but they face difficulties in accessing salaried face the additional challenge of integrating displaced per- employment when competing with other youth. Women sons: while over 700,000 have returned, they face multiple tend to be employed for the lowest-paying unskilled tasks challenges in securing land rights, accessing shelter and that require intense labor, such as tea plucking or rubber infrastructure, and developing livelihoods. tapping. Despite being income earners, there is substan- tial anecdotal evidence that the wages of estate women 25. Finally, gender inclusion is critical, particularly are often collected by their husbands or fathers who often as it relates to the labor market. Women made up 53 spend it on alcohol. Alcoholism and associated abuse of percent of the working age population in 2012, but only women is much higher in the estate sector. 34 percent of the employed population, a figure that has remained static for decades. Women are less likely to par- 23. The estate sector faces structural challenges that ticipate in the labor market, but when they decideto look will likely impact the population going forward. Wages for work, they are more like- Women’s participation have risen by over 10 times since privatization in 1992 – ly to be unemployed. Social due in part to the strong collective bargaining power of norms related to a wom- estate workers, linked to a powerful political party repre- an’s role in the household in the labor market senting them. At the same time, Sri Lankan tea producers and especially as related to has remained static are facing increasing competition from Kenyan and Indian childcare responsibilities producers who have lower costs of production and higher restrict women’s opportu- for decades productivity. As a result, the future welfare of estate com- nity to participate in the la- munities is at risk due to narrowing surpluses enjoyed by bor market. However, beyond social norms, gender wage Regional Plantation Companies (RPCs) and a socio-eco- gaps and occupational segregation dissuade and con- nomic structure that may not be tenable over the long strain women from participating in the labor force. At the term. same time, the formal legal framework for labor prevents women from taking up night work or part-time work in the 24. Beyond the locational concentration of the pop- growing service sector, and the laws governing maternity ulation, inclusion across ethnic and religious groups is benefits make employers bear the entire cost, potentially critical. Although partially correlated to spatial disparities, deterring employers from hiring women. poverty outcomes across ethnicity and religion illustrate a second important challenge for social inclusion. Differenc- es in poverty outcomes across ethnic groups are related The Cross-Cutting Governance to employment and other opportunities. This is the case Challenge even when the North and East are excluded from compar- isons. As more youth migrate across the country in search 26. The governance challenge manifests itself in of jobs, equal opportunities will be critical. Sri Lankan many ways which taken together constitute the fun- Tamils and Sri Lankan Moors have relatively high levels of damental constraint on progress on the twin goals. poverty, as detailed in Chapter V; however, empirical anal- Governance issues are cross cutting and underlie in many ysis finds that most of the difference in monetary pover- important ways the three challenges outlined above. Gov- ty is related to inequality of opportunities. For a range of ernance is obviously central to the quality and probity of indicators, the most recent household survey shows that public expenditure as well as the government’s capacity Sri Lankan Tamil households have lower access to basic to provide for equality of opportunity for the poor and services, including drinking water within their premises, bottom 40 percent to improve their welfare. Moreover, the the availability of a pipe-borne line nearby their house, a quality of governance is integral to addressing corruption 16 | I. Executive Summary concerns and sustaining public trust. It is also integral to 28. Other risks to sustainability are associated with revenue performance, particularly the effectiveness of tax economic stability in the context of an uncertain ex- and customs administration. The most prominent manner ternal environment and environmental issues. External in which governance acts as a constraint is in how the state risks include a chronic current account deficit and rela- carries out regulatory functions for the economy. Policies tively low reserve adequacy metrics; a gradual but steady that orient the economy inward, such as the convoluted decline in goods exports; an already high external debt tax system, restrictive land and labor market regulation, burden and a rising cost for external financing as Sri Lanka and inefficient subsidies – and the related quality of ad- must now borrow on commercial terms; and disappointing ministration thereof – reflect areas where governance is a levels of foreign direct investment. While the current ac- critical constraint. This burden of government regulation count deficit has decreased in recent years, in part thanks has led to a large informal sector, which negatively impacts to slow increases in remittances and tourism, it remains fi- improvements in productivity. Governance weaknesses nanced largely by debt-creating inflows. At the same time, have further led to significant expansion of the public sec- Central Bank foreign exchange reserves are at the lower tor’s role in the labor market and certain economic sectors. end of what is considered adequate by standard metrics. This expanded role in the economy contributes little to ef- Moreover, Sri Lanka is in the fective use of the country’s resources or productivity gains, midst of its demographic whether it is interventions in agriculture, multiplying tax transition, and is projected Sri Lanka is projected incentives, or absorbing a significant portion of the labor to age fast in the next few to age fast in the next force. Finally, ensuring the provision of key public goods such as infrastructure and public services is a core function decades. As the elderly typ- ically run down their sav- few decades of government; the extent to which there is inequality in ings and require additional access to such goods reflects areas where strengthened public spending in the form of pensions, social protection governance is warranted. and healthcare, their increasing share in the population means that national savings will fall even further. Finally, preserving Sri Lanka’s natural asset base and managing en- Sustainability Challenges vironmental impact as the country continues its structural transformation, including urbanization, will be critical to 27. Sustainability of Sri Lanka’s development will in- sustaining progress on the twin goals. Sri Lanka will con- volve keeping momentum towards reconciliation and tinue to face environmental risks due to natural disasters successful completion of institutional reforms. Achiev- as well as the long-term impacts of climate change, which ing a lasting settlement of conflict that ensures peace and by one accounting will result in reductions of 1.2 percent security for Sri Lankans is the sine qua non condition for of GDP per year by 2050. progress. While circumstances are unique to every country and conflict is not minent, Achieving a lasting global experience suggests Conclusions that Sri Lanka is “at risk” given settlement that its history of internal conflict. 29. Sri Lanka’s has had impressive development ensures peace Achieving reconciliation and gains but there are strong indications that drivers addressing issues that led to of past progress are not sustainable. Solid economic and security for Sri grievances that, in turn, fu- growth, strong poverty reduction, overcoming internal Lankans is a sine qua eled conflict in the past will conflict, effecting a remarkable democratic transition in non condition for en be critical. Sri Lanka has tak- notable steps along this recent months, and overall strong human development outcomes are a track record that would make any coun- progress path, including following try proud. However, the country’s inward looking growth up on extensive recommen- model based on non-tradable sectors and domestic de- dations by its Commission of Inquiry on Lessons Learned mand amplified by public investment cannot be expected and Reconciliation (LLRC). Important measures have oc- to lead to sustained inclusive growth going forward. curred in recent months, including the appointment of a civilian as governor in the north and beginning to return 30. A systematic diagnostic points to fiscal, compet- some land occupied by the military after the conflict end- itiveness, and inclusion challenges as well as cross-cut- ed. This momentum will need to be sustained. Sri Lanka ting governance and sustainability challenges as pri- will also need to follow through on major institutional re- ority areas of focus for sustaining progress in ending forms now taking place to achieve a lasting political settle- poverty and promoting shared prosperity (Table 1.1). ment around a government that is more transparent and The fiscal challenge is due above all to poor revenue collec- accountable. tion, compounded by inefficiencies in public expenditures Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 17 that result in rigidity and underinvestment in human capi- 32. There is a particularly strong nexus of issues tal. The competitiveness challenge is a mix of several areas around providing for skills development that meets where Sri Lanka is behind comparator countries, most no- the needs of Sri Lanka’s economy. On one hand, there tably in fostering adequate skills in the labor force, but also are important elements of state performance needed in other areas such as FDI attraction, investment climate, to improve the population’s skills mix: its ability to cre- and promotion of innovation. The inclusion challenge is ate more fiscal space to provide quality education to the both spatial in the urban areas and remote “pockets of population, the efficiency of resources directed towards poverty” as well as cross cutting across ethnic, gender and human capital development, its ability to listen to and age differences in Sri Lanka’s population. Governance is a partner with the private sector on ensuring that the right challenge in all areas, but is particularly manifested in reg- skills are being provided, and the impact that it has on the ulatory constraints and an outsized public sector. Finally, labor market given its outsized role as an employer. At the there are important sustainability risks, including the need same time, investment in skills, particularly with public fi- to: maintain peace and security; carry through with gover- nancing, is integral to equipping the bottom 40 percent nance reforms; address longer-term economic challenges with capacity to get good jobs, a fundamental means of of an aging population; and balance imperatives to grow boosting shared prosperity. A more skilled labor force in with stewardship of Sri Lanka’s natural assets as a basis for turn helps Sri Lanka become more competitive, including lasting prosperity and quality of life. within global value chains, as well as a more attractive des- tination for FDI. 31. There are particularly important areas of syner- gy that provide for progress on inclusion, sustainabil- 33. Addressing the constraints and sustainabili- ity and growth. For instance, effective governance of cit- ty risks diagnosed in this report will require effective ies will not only be critical for addressing spatial inclusion leadership. Consultations conducted while preparing this challenges, but could also improve the benefits of urban diagnostic showed that many of the identified constraints agglomeration and raise the level of overall growth and were known, at least on an intuitive level. Indeed, with re- job-creation. Good governance in urbanizing areas is also gard to several constraints, reforms or government inter- important to balance social, environmental, and economic ventions have been initiated to address problems such as equity concerns to allow for Sri Lanka to benefit long term equality of opportunity in underserved areas or improving from its relatively unharmed natural asset base. Similarly, Sri Lankans’ skill sets. The present government has articu- improving equality of opportunity (including addressing lated further plans to address other constraints outlined in land claims) across ethnic groups is likely to be crucial for this diagnostic. Yet there also remain interests that support improving social stability and sustainability of peace. Clos- the status quo, whether they are specific tax exemptions ing gender gaps is not only important in terms of social or limitations on the number of slots available in higher inclusion, but is also critical in terms of the broader chal- education institutions. Sri Lanka is at a crossroads in its lenge of raising competitiveness and ensuring shared economic growth model and its governance framework prosperity, particularly given that an aging population will that will provide for an effective state to facilitate growth increase the dependency rate. and ensure social inclusion. Effective leadership will be needed to steer it forward on a path that will continue its strong progress in ending poverty and promoting shared prosperity. 18 | I. Executive Summary Table 1.1 Priorities to end poverty and promote shared prosperity in a sustainable Priorities Rationale FISCAL Reform the tax regime and improve tax administration to Fiscal sustainability a key precondition for progress in all areas, improve revenue performance including macroeconomic stability. Greater fiscal space allows for Improve the adequacy and effectiveness of spending addressing equality of opportunity through increased social spending, Improve the amount of financing and efficiency of social especially important for inclusion. Efficiency of social protection has protection direct impact on ending poverty. Evidence base is strong. COMPETITIVENESS Review and revise the country’s trade-related policies Trade and adoption of new technologies promote diversification, Provide more resources and quality-enhancing management in external sustainability, and growth, which translates to good jobs. the education sector to expand skilled workforce and overcome Overcoming skills mismatches contributes to growth and participation skills mismatch of the bottom 40 percent, including minorities and women. Evidence Promote innovation by establishing linkages between R&D base is strong for skills and trade policy issues. institutions and networks of entrepreneurs INCLUSION Proper urban management and effective governance of cities to Urbanizing areas are associated with growth and an absolute majority address locational concentrations of poverty of poor are proximate to these areas. Ensuring continued benefits Multi-sector interventions to reduce poverty and promote of agglomeration will help progress for the majority of the poor. For employment opportunities in areas with the highest poverty those living in more remote areas, more targeted interventions will be rates (North, East, Moneragala, and estates) needed to ensure equality of opportunity through improved service Improve equality of opportunity across ethnic groups, regardless delivery and greater participation in the labor force. Evidence base is of where they reside very strong. Increase labor force participation of women and ensure equal opportunity in access to jobs, political and private-sector leadership GOVERNANCE Improve the regulatory environment to allow firms to grow and Governance has cross-cutting impact on all other challenges. In enhance overall productivity in the economy particular, labor, land, and other regulation create major distortions Review the regulatory role and participation of the public sector in the economy. The size of the public sector leads to inefficient use of in the economy public resources and distorts labor markets. The ability of government Improve the efficiency of the public sector to carry out core functions depends on effectiveness of the public sector. Evidence base is strong. SUSTAINABILITY Sustain peace and security through long-term reconciliation Peace is sine qua non for continued investment, growth, and efforts personal well-being of large segment of the population. Sustaining Develop a more accountable and effective state the state’s institutional capability over the long term is integral Place heavier emphasis on direct investment and equity portfolio competent facilitation of private-sector-led growth. Macro-economic flows than debt and environmental sustainability are preconditions for continued progress as well as capitalizing on the country’s asset base. Evidence Preserve natural assets and address the impact of climate change of associated risks is strong. Address the long-term fiscal sustainability concerns related to population aging Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 19 II. COUNTRY CONTEXT 20 | II. Country Context A. Political and Social Context conflict in the 1970s and 1980s1, direct and indirect costs of conflict through additional expenditures, losses in phys- 34. Sri Lanka is in many respects a development ical and human capital, and foregone investment have success story. With economic growth averaging over been estimated to be equivalent to over 5 percent of GDP 7 percent a year over the past five years on top of an av- per year during the period 1978-2005.2 This calculation of erage growth of 6 percent the preceding five years, Sri economic costs does not include the impact of loss of life Lanka has made notable strides in reducing poverty and and other physical and psychological trauma. promoting shared prosperity. The national poverty head- 36. The end of the conflict has led to much greater count ratio declined from 22.7 to 6.7 percent between security for Sri Lankans and an opportunity to achieve 2002 and 2012/13, with most of the reduction occurring lasting reconciliation. There is no longer the pervasive in the early part of the past decade. Growth has been pro- threat of violence that had long impacted development. poor for most of the past decade, with consumption per The state controls law and order across the island, result- capita of the bottom 40 percent growing at 3.3 percent ing in improvements in overall security. Security in turn a year, compared to 2.8 percent for the total population. provides for higher quality of life and stimulates economic Other human development indicators are also impressive activity at many levels. At the same time, the major po- by regional and lower middle-income standards. Sri Lanka litical parties associated with the Tamil population work outperforms nearby country comparators on most Mil- within Sri Lanka’s institutional framework at provincial and lennium Development Goals (MDGs), particularly with re- national levels while continuing to articulate their com- gard to poverty reduction, health, and environmental sus- munity’s issues. The main Tamil political grouping played tainability. Coverage for primary school is near universal, an important role in supporting the January 2015 election while secondary and tertiary enrollment has substantially of Sri Lanka’s new president, Maithripala Sirisena. Security increased. Maternal and infant mortality rates are now at and inclusive politics provide space for coming to a lasting very low levels, and life expectancy, at 74 years, has been settlement that would overcome grievances that fueled above its regional peers for over a decade. (See Appendix conflict in the past. 1.1 for review of Sri Lanka’s performance on MDGs.) 37. There have been significant efforts to rebuild 35. The country’s achievements are impressive given conflict-affected areas. Sri Lanka has heavily invested in the complex relationships among its communities that developing infrastructure throughout the country over have led to conflict in the past. Sri Lanka is home to eth- the past five years, including in the conflict-affected areas nic majority Sinhala; Sri Lankan Tamils, of whom many are of the north and east. A total of 5.2 percent of all budget concentrated in the north and east; Moors (Muslims) con- expenditures excluding interest payments were spent di- centrated in the east, northwest, coastal areas of the south, rectly on reconstruction efforts in the Northern Province and urban areas; Indian origin Tamils concentrated in the alone in the period 2009-2013.3 These efforts have includ- highlands and estate sector; and other less numerous eth- ed a painstaking demining effort covering targeted areas nic groups including Malays and Burghers. Urban popula- comprising over 2000 square kilometers that is 95 percent tions, particularly the capital Colombo, have diverse ethnic complete as of the beginning of 2014, making farming composition. Providing for social inclusion and peaceful possible in many fields which had been off limits. While co-existence and interaction levels of public service provision remain lower in the north Providing for social been a persistent challenge, among communities has and east, there has been visible progress in improving road and rail networks and installing housing, power transmis- inclusion among with inter-communal griev- sion, water supply systems and other infrastructure. The communities has ances leading to several out- roughly 700,000 internally displaced people caused by the bursts of violence before and been a persistent after independence in 1948. conflict have almost all returned to their homes or have otherwise voluntarily resettled elsewhere. The population challenge These tensions were a driv- in former conflict areas continues to face many hurdles in ing force contributing to the emergence in the late 1970s of armed Tamil militant formations, which in turn came to be dominated by the Liberation Tigers of Tamil Eelam 1  In addition to conflict involving Sri Lankan Tamils, there were two insurrections of leftist political groups composed of mostly Sinhalese (LTTE). A four-phased war between the LTTE and the Sri against the Sri Lankan state in 1971 and 1987-89. There was also conflict Lankan state spanning 26 years ended with the military in preceding decades among Sri Lankan Tamil armed groups, ending defeat of the LTTE and deaths of most of its leaders in May with the LTTE virtually eliminating its rivals. 2009. Taken together with youth insurrections that led to 2  Institute for Policy Studies. 2012. 3  Ministry of Finance, 2014 Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 21 rebuilding their lives but resettlement after the conflict 40. Institutional reforms and efforts at reconciliation has been overall positive with 93 percent resettled on their are occurring against the backdrop of a fluid Sri Lank- own lands.4 an polity. There are two major national parties and a large number of smaller parties, including several with affiliation 38. Particularly after the election of President Siris- to ethnic groups. Electoral competition has been robust at ena in 2015, the government has taken actions to ad- national and provincial levels, most notably in the recent dress grievances of the Sri Lankan Tamil community. presidential elections. At the same time, public figures ex- Following the end of the conflict, the preceding govern- ercise substantial autonomy – with prominent instances ment established the LLRC and implemented several of of switching party allegiances, most notably in the recent the commission’s recommendations. In particular, North- presidential elections. The fluid polity has prompted for- ern Provincial Council elections were held in 2013 and mal and informal coalition building as well as the need for were won by the main Tamil opposition party. Steps to regular attention from the country’s leadership to sustain address grievances have been accelerated under Presi- support from often diverse bases. The fluidity of the en- dent Sirisena, most notably: the appointment of a civilian vironment has been evident in securing the passage of as governor in the Northern Province; the commitment to constitutional and electoral reforms that required exten- a domestic mechanism to address issues of accountabili- sive political negotiations. A new government involving ty for allegations of misconduct during and particularly at a grand coalition has been formed after the August 2015 the end of the conflict; and the return of some of the lands general elections and is in the process of formulating its that had been taken for military bases in the North and economic and other policies. East. The more pro-active stance of government responds to a key LLRC finding on the causes of conflict: “Successive 41. As Sri Lanka aspires to become a higher mid- governments since independence have been unable to dle-income country, it will need to adjust its develop- fully resolve, and in some instances actually contributed to, ment model. Growth in the last five years is in substantial communal tensions, particularly those involving the Tamil part due to a “peace dividend”, which included significant community.” While much remains to be done on reconcil- reconstruction efforts. Going forward, economic growth iation, these steps work towards providing for long-term will likely require continued structural changes in the sense of security, justice and jobs for all communities, all of economy towards greater diversification and productiv- which are critical factors for avoiding renewal of conflict.5 ity increases and a reduction in the role of agricultural employment from its present share of a third of the pop- 39. Sri Lanka is also at the threshold of major insti- ulation. Although Sri Lanka has excelled in overcoming tutional and political reforms advocated by the new human development challenges typical to a low-income political leadership elected in 2015. Since the passage country, its service delivery systems in education, health of its 1978 Constitution, Sri Lanka has been dominated and other areas must now adjust to face new and chang- by an “Executive Presidency” that enjoyed wide-ranging ing demands typical of a MIC. Imperatives to improve so- powers, including the unlimited right to appoint and dis- cial safety nets will increase owing to an aging population miss key officers of nearly all state institutions and no ac- that has passed its demographic peak. Finally, increasing countability to other state institutions. The preponderance affluence and information will lead to higher expectations of the presidency created a centralized government and for the state to perform in order to facilitate growth, pro- decision-making apparatus with weak checks and balanc- vide a higher level of services, and demonstrate increasing es. Sirisena’s victory in elections over two-term President responsiveness to a more demanding citizenry. Rajapaksa, the country’s dominant political figure for the preceding nine years, was based on a platform of good governance that received diverse support. His govern- B. Poverty and Shared Prosperity ment has prioritized securing passage of constitutional 42. Economic growth in Sri Lanka has been among amendments to reduce the powers of the presidency the fastest in South Asia in recent years. Growth has av- while strengthening parliament, as well as legislation set- eraged 6.3 percent between 2002 and 2013, with per cap- ting up a right to information regime, strengthened audit ita GDP rising from US$869 in 2000 to US$3,280 in 2013. and procurement regimes, and more vigorous anti-corrup- Moreover, the average growth rate accelerated to 7.5 per- tion efforts. cent between 2010 and 2013, reflecting a peace dividend and an aggressive policy thrust towards growth since the internal civil conflict ended. This growth is high as com- 4  GoSL and United Nations. Sri Lanka Joint Needs Assessment Final pared to regional and MIC peers, and has been accompa- Report. 2014. nied by low inflation (Figure 2.1). Year 2014 also saw a con- 5  World Bank 2011 World Development Report. tinuation of the momentum with the economy growing by 22 | II. Country Context Figure 2.1 GDP growth and inflation over time and relative to other MICs A. Sri Lanka. GDP growth, 2000-2013 B. Average GDP growth and inflation, 2009-2013 9 8 7.5 8 India Indonesia 7 Bangladesh 6.0 6 GDP growth ( percent) 6 Vietnam Inflation y-o-y (%) 4.3 Sri Lanka 5 Hong Kong, SAR, China Cambodia 4 4 Malaysia Philippines 2 3 2 Thailand Singapore 0 1 Korea 0 -2 2 3 4 5 6 7 8 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2012 2013 2011 GDP growth (%) Sources: World Economic Outlook, Department of Census and Statistics 7.4 percent compared to a 7.3 percent growth reported in with the figures on total household income reported by 2013 on robust growth in industry and services. the Department of Census ans Statistics (DCS), which re- mained roughly constant in real terms. The discrepancy 43. Strong economic growth for over a decade has arises mainly because average household size fell during led to an important decline in poverty and promoted this period. Because larger households require more in- shared prosperity. Poverty, measured by per capita con- come than smaller households to maintain the same sumption, fell from 22.7 percent in 2002 to 6.7 percent in standard of living, per-capita income is preferred to total 2012/13 using the national poverty line6, which is equiva- income as a measure of household welfare. However, for lent to about US$1.50 in PPP terms. Extreme poverty fell poorer households measured as those with lower per capi- from 13.2 to 3.2 percent using the US$1.25-a-day poverty ta consumption, growth in real per capita income was over line, while moderate poverty fell from 56.2 to 32.1 percent twice as fast, and was in line with similar growth rates in using the $2.50-a-day poverty line, commonly used across per capita consumption. middle-income countries (Appendix 1.2), over the same time period (Table 1).7 45. The reduction in poverty for the 2002 – 2012/13 period is also reflected in multidimensional measures. 44. Poverty reduction measured by per capita con- Households in the bottom 40 percent were increasing- sumption is also reflected in increased per capita in- ly able to afford to purchase non-food items, as the food comes, particularly for the poor. Between 2006/07 and budget share for this group fell from 67 percent in 2002 to 2012/2013, average per capita incomes grew only slightly, 56 percent in 2012/13. Ownership of durable assets also about 2 percent overall (Figure 2.2A). Growth in household rose, especially among the poorest. Primary education at- income reported here is on per capita terms, and contrasts tendance is essentially universal. Secondary school atten- dance is also high and continued to nudge upward during this period. Completion, on the other hand, saw a major increase, as the share of 17 and 18 year olds who complet- 6  Given the ongoing conflict, a few regions were not included in the ed secondary school rose from 40 to 60 percent between 2002 household survey. When looking at comparable regions, the decline 2002 and 2012/13. Health indicators also improved during in poverty was from 22.7 percent in 2002 to 6.1 percent in 2012/13. this period. The rate of infant mortality fell from 13 to eight 7  The national poverty line is expected to be updated soon in order to: children per thousand births, and the rate of under-nutri- (i) update household consumption patterns (the current line assumes the 2002 consumption pattern), (ii) incorporate methodological best prac- tion, while still high, decreased from 30 to 25 percent (Fig- tice particularly with respect to the minimum calorie requirement and ure 2.2B). the appropriate amount of non-food expenditure consistent with that minimum threshold, and (iii) set a more ambitious benchmark, appropri- 46. Despite the reduction in extreme poverty, living ate for a country at Sri Lanka’s stage of development, to measure future standards remain low for most Sri Lankans and a large progress against poverty. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 23 Table 2.1 Poverty and inequality trends Full Sample Excluding Northern and Eastern Provinces 2002 2006/07 2009/10 2012/13 2006/07 2009/10 2012/13 Poverty gap US $1.25 a day in PPP terms 13.2 6.8 3.8 3.2 6.9 3.5 2.8 US $2.50 a day in PPP terms 56.2 44.4 37.1 32.1 44.4 35.3 29.9 National poverty line 22.7 15.3 8.9 6.7 15.5 8.2 6.1 Poverty gap 5.1 3.1 1.7 1.2 3.1 1.6 1.0 Severity 1.6 0.9 0.5 0.3 0.9 0.5 0.3 Inequality* Gini 0.402 0.397 0.361 0.387 0.330 0.308 0.328 Theil 0.323 0.325 0.268 0.317 0.212 0.186 0.234 p90/P10 5.122 4.981 4.300 4.738 3.971 3.596 3.821 Shared Prosperity** 2002-06/07 2006/07-09/10 2009/10-12/13 2002-06/07 2006/07-09/10 2009/10-12/13 Average 1.95 3.33 4.23 1.95 3.60 4.25 Bottom 40 percent 2.59 4.91 2.84 2.59 5.40 2.83 * The second set of results (excluding Northern and Eastern Provinces) is generated using a version of the consumption aggregate which excludes durables ** The first set of results (Full sample) keeps all districts available in each pair of surveys. Both set of results use a version of the consumption aggregate which excludes durables Figure 2.2 Income and multidimensional poverty measures have improved A. Average growth in annualized real per capita incomes from B. Education and health outcomes have improved 2006-2012, by decile of per capita consumption 0% 1% 2% 3% 4% 5% 6% Infant Mortality rate Poorest Decile 4.6% (per 10 births) 2nd Decile 3.9% Undernutrition rate 3rd Decile 4.8% School attendance (12-18) 4th Decile 5.2% Secondary School Completion Top 60 percent 2.5% 0% 20% 40% 60% 80% 100% Average 2.2% 2012 2009 2006 2002 Source: FAOSTAT, WDI, and World Bank staff calculations based on HIES, DCS. Source: World Bank Poverty Assessment, 2015 based on 2006/7 and 2012/13 HIES School estimates exclude Northern and Eastern provinces for comparability. 24 | II. Country Context Figure 2.3 Extreme poverty-growth semi-elasticity 1 0 -0.2 -0.4 -0.6 -0.8 -1 -1.2 -1.4 -1.6 Bangladesh Tajikistan Colombia Pakistan Indonesia Nicaragua Georgia Vietnam Bhutan Philippines Bolivia Peru Nepal India Lao PDR Sri Lanka Similar GDP Similar GDP Countries in the region Other (2002- per capita in 2002 growth between (circa 2002 - 2012) Conflict 2012) 2002 and 2012 Countries Source: World Bank 2015 Poverty Assessment (forthcoming) 1/ Defined as the change in the US1.25-a-day poverty headcount rate (in percentage points) due to a 1 percent increase of per capita GDP: (Change of poverty headcount in period/ number of years in period)/(Annualized increase of per capita GDP) share of the population remains vulnerable to pover- Income and Expenditure Surveys (HIES). Per capita con- ty. Despite the low levels of extreme poverty, roughly one sumption of the bottom 40 percent grew at a rate of 3.5 quarter of Sri Lankans are nearly poor, as defined by living percent for the 2002-2012/13 period, considerably faster above the official poverty line but below US$2.50 per day than the average growth of 3 percent for the total popu- in 2005 PPP terms. The living lation over the same time period.8 Simple decompositions Despite low levels standards of the near-poor show that most of the reduction in poverty was due to are closer to those of the of extreme poverty, poor than those living above strong consumption growth, roughly one quarter US$2.50 per day. For exam- which shifted the entire distribution to the right, as The strongest of Sri Lankans are ple, the near-poor spend opposed to large chang- reduction in poverty an average of 59 percent of es within the distribution. was from 2002 to nearly poor their budget on food, only However, when the decade six percentage points less is broken into sub-periods, 2009/10 than the poor, as opposed to 42 percent by households growth was disproportion- consuming more than US$2.50 per day (2005 PPP). ately in favor of the poorer half of the population (“pro- poor”) up until 2009. Although poverty continued to de- 47. Moreover, while the decline in poverty was cline between 2009/10 and 2012/13, growth of the bottom strong, it was below what one could have expected giv- half of the distribution was slower than growth for the top en the sustained high growth rates over the last decade half, leading to an increase in inequality. This can easily be Indeed, a 1 percent increase in per-capita GDP reduced the seen in the growth incidence curves (GICs) shown in Figure US1.25-a-day poverty rate by only 0.2 percentage points 2.4. The x-axis shows households ordered from poorest to while a similar increase in growth led to stronger reduc- richest, while the y-axis shows growth in household con- tions in extreme poverty in other regional and developing sumption. Between 2002 and 2009/10, growth was faster countries (Figure 2.3). It has, however, been in line with at the bottom of the distribution, thus leading to a nega- other post-conflict countries. tively sloped GIC – denoting pro-poor growth. In contrast, 48. Growth was higher in the post-war period but the strongest reduction in poverty and improvement in shared prosperity occurred in the early part of the 8  The reported rates refer to the annualized growth rates, considering 10-year period covered by the past three Household the period 2002-2012/13 as 10 ½ years long. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 25 Figure 2.4 Growth incidence curves: per capita consumption growth A. 2002-2009/10 B. 2009/10-2012/13 6 6 5 5 4 4 3 3 2 2 1 1 0 0 Growth Incidence Mean growth rate 95% Confidence Interval Source: Comparable regions in HIES 2002, 2009/10, 2012/13. between 2009/10 and 2012/13, growth at the top of the 51. Other multidimensional measures also show in- distribution was faster, leading to a positively sloped GIC. equality in outcomes. Sri Lanka successfully reached full enrollment in primary education (grades 1 to 9), but ed- 49. The most recent growth pattern has led to an in- ucation attainment of higher levels of education remains crease in inequality. The corollary of stronger growth for strictly correlated to the well-being of households. For ex- the top of the distribution between 2009/10 and 2013/14 ample, educational attainment among the poor is almost is that inequality increased. half of what it is for the non-poor. Although the level of Growth was pro-poor Standard measures of in- education attainment has slowly increased both for poor and non-poor individuals, poor individuals have a very low up until 2009 while equality, such as the Gini co- efficient, increased from 0.36 likelihood of completing collegiate education. Similarly, inequality increased in 2009/10 to 0.39 in 2012/13, the poor are characterized by having lower access to elec- between 2009/10 leading to an inequality level tricity, telephone, water, and sanitation and having to trav- el further to reach health services. These characteristics are and 2013/14 almost as high as the one especially true for those living on less than US$1.25-a-day registered in 2006/07, before (Appendix 1.3) the end of the civil war (Ta- ble 1 on page 13). In effect, rising inequality tempered the 52. Moreover, there is significant locational con- poverty-reducing impact of growth. centration of poverty in Sri Lanka. This is true both for monetary and multidimensional outcomes, including 50. Inequality has not only increased, but disparities education, nutrition and access to services. The share of across the different ethnic and religious groups remain. people living under the national poverty line, known as Poverty declined fastest for Sri Lankan Moors (Muslims): if the headcount rate, is concentrated in three main areas in 2002 one out of four Sri Lanka Moors was poor, 10 years (Figure 2.6). The first is the former conflict districts in the later only about one every 18 Sri Lanka Moors was poor Northern Province, Mullaitivu, Manar, and, to a lesser ex- (or 6 percent), very close to the share of Sinhalese who are tent, Kilinochchi District. The second is Batticaloa in the poor. In 2012/13, Sri Lankan Tamils had the highest rates Eastern Province, and the last one is Moneragala in the Uva of poverty among ethnic groups (Figure 2.5A). Among the Province. Areas with higher poverty rates also tend to have a larger portion of the bottom 40 percent. different religious groups surveyed in 2012/13 (which, in most cases, have a strong correlation with ethnicity), Hin- 53. Notwithstanding high rates of poverty in specif- dus had the highest poverty rates: 12 percent were poor, ic remote districts, the majority of the poor and as well as opposed to 6 percent of Buddhists, Muslims and Chris- as the bottom 40 percent live in populous, effectively tians (Figure 2.5B). urban areas in the center of the island. The location of 26 | II. Country Context Figure 2.5 Poverty headcount rates, by ethnicity and religion (national poverty line) A. Poverty headcount rate by ethnicity B. Poverty headcount rate by religion 40 40 25.5 26.4 27.5 30 25.0 30 23.9 22.2 23.3 % 20 % 20 12.0 11.6 10.3 9.4 10 5.9 6.0 10 6.0 5.8 6.2 0 0 Sinhala Sri Lanka Indian Tamil Sri Lanka Buddhist Hindu Islam Christian Tamil Moors 2002 2006/07 2009/10 2012/13 2002 2006/07 2009/10 2012/13 Source: Own estimates based on HIES. Department of Census & Statistics Note: Includes full samples available for each HIES. The results are similar when using comparable samples. Figure 2.6 Poverty headcount rates, 2012/13 Figure 2.7 Distribution of the poor, 2012/13 (by division) (absolute number of poor) Source: World Bank & DCS Poverty Map. Poverty line is Sri Lankan national poverty line. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 27 Figure 2.8 Net contributions to poverty reduction, 2002-2012/13 Returns Paid non- farm 27.9% Returns Self-employed farm 20.4% Returns Paid farm 11.2% Age, gender, ethnicity, regio 9.6% International remittances 9.6% Education 8.7% Dividends 7.5% Transfers in kind 6.8% Domestic transfers 4.7% Returns Self-employed non- farm 3.9% Rents 2.3% Pensions 1.6% Returns Self-employed mix 1.2% Occupation 0.7% Residuals -0.7% Relief assistance -2.2% Other nonlabor -4.9% Samurdhi -9.6% Consumption - Income ratio -20.2% -30% -20% -10% 0% 10% 20% 30% 40% Source: World Bank 2015 Poverty Assessment. Estimates based on counterfactual consumption per capita distributions based on empirical models that simulate the observed change in each factor on overall household consumption per capita one at a time, thus allowing for changes in poverty. the poor broadly corresponds to the location of Sri Lan- agriculture (Figure 2.8). Increased returns to agriculture ka’s population as a whole. Figure 2.7 shows estimates of accounted for about 31 percent of the decline, of which the number of people living in poverty. Kurunegala in the roughly two-thirds were higher returns to self-employed center of the country, for instance, is home to 7.6 percent farmers. The other main factor was an increase in the re- of the country’s poor people even though only 7 percent turns to paid non-farm work, which accounted for 28 per- of its population lives under the official poverty line. In cent of the poverty decline. Combined, increases in the contrast, Mullaitivu, Kilinochchi, and Mannar in the North, returns to work explain nearly 60 percent of the reported have very high estimated poverty rates (20.8-31.4 percent), poverty reduction. These increases in returns are associat- but account for less than 5 percent of poor people nation- ed with an increase in average real wages, which could be wide due to the low population density in those regions. due to either higher productivity or improved relative pric- es for the poor, given many are net producers. The finding of sustained increases in real wages over the decade is in C. Understanding Changes in Poverty line with results from alternate surveys conducted by the Central Bank, which show a sharp increase in services and 54. Between 2002 and government real wages from 2002 to 2013 and in industry Increased labor 2012/13, most of the re- real wages in 2013. incomes account for duction in poverty was due to higher labor in- 55. Private transfers in the form of remittances, and nearly 60% of reported comes,9 and, in particular, the increase in the working age population also helped. poverty reduction to increased earnings, as Between 2002 and 2012/13 remittances increased from opposed to higher em- 0.4 to 0.9 percent of total incomes and total consumption ployment or higher trans- of the poorest 10 percent of households (Figure 2.9). Even fers. Most of the increase in labor income was, in turn, though this was an increase relative to the incomes of the due to increased returns to work both in and outside of poor, most remittances in absolute amounts go to the richer part of the population. The age composition of the workforce also contributed to poverty reduction. The com- 9  Growth in real per capita labor income reported here is in line with position of the workforce in terms of gender, ethnicity and overall growth in per capita income, partly due to smaller households as religious composition remained stable over the course discussed in paragraph 41 and footnote 6 above. of the decade. However, the share of 15-29 year-olds de- 28 | II. Country Context Figure 2.9 Most remittances in absolute amounts go to the top of the 56. In contrast to private transfers, public transfers did not make a net con- distribution (percent of total household consumption) tribution to poverty reduction over the past decade. Public transfers (particular- 6% ly the Samurdhi program) declined in real Poorest decile terms, and as such, its net contribution to 5% Richest decile reducing poverty was negative.10 In fact, re- sults from analysis of the HIES show that the 4% decline in poverty would have been 10 per- cent greater had the real value of Samurdhi 3% remained constant. Finally, while both the improvements in education and the demo- 2% graphic dividend (the larger share of work- 1% ing-age adults) helped to reduce poverty, these were relatively small contributors to 0% poverty reduction (Figure 2.8). 2002 2006/07 2009/10 2012/13 Household per capita consumption deciles 10  That is, if nothing else had changed, poverty Source: Own estimates based on HIES. would have increased simply because the value of these transfers was lower in real terms in 2012/13 rel- ative to 2002. There are multiple social programs in Sri Lanka. The main direct cash transfer program is the clined from 26 to 20 percent between 2002 and 2012/13, Samurdhi Poverty Alleviating Program, which includes making the overall workforce relatively more experienced, an income-support scheme that grants a monthly al- lowance according to the number of family members and thus likely to bring in higher labor incomes. It is also in each household, an insurance scheme that provides a strong signal that the population is aging, which raises cash allowances during births, deaths and hospitaliza- concerns about long-term fiscal sustainability (see Chap- tion of family members, nutrition programs for preg- nant and lactating mothers and children of beneficiary ter VI on economic sustainability and aging). families, and scholarship programs for children. Figure 2.10 Increased labor demand is reflected in wage and employment growth 4.0% 0.4 Annual change in share of employment 3.0% 0.3 Annual change in real wage 2.0% 0.2 1.0% 0.1 0.0% 0.0 -1.0% -0.1 -2.0% -0.2 -3.0% -0.3 -4.0% -0.4 s rce s ces ces rs lture ing ring tilitie tructio n ion ervi ervi e ricu Min ufactu blic u s o m me u n icat d s d s Oth Ag Con C mn ent e te Ma n Pu & co ess-ori ien r t s i l y-or m spo usin & fa Tran ial & b u nity n c m Fina Com Annual change in share of employment 2002-2012 (pp) Annual change in real wage of wage workers 2002-2012 (%) Source: World bank Poverty Assessment, 2015. Notes: Employment is change in percentage point change in share of workers employed in each sector. Real wage increase is the increase in real wages, including only wage workers. Wages are deflated using the Colombo Consumer Price Index. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 29 57. It is very difficult to attribute the reasons for increases that led to higher labor earnings for agricultural the increase in labor incomes. To the extent that there workers. was both an increase in employment as well as increases in wages, this is consistent with an overall increase in de- Structural Transformation mand for workers. Increases in labor demand, as indicated by increases in employment and/or wages, appear to be 59. The economy saw a shift from agriculture to in- broadly spread across many sectors rather than concen- dustry and services in the last 15 years (Figure 2.11A). tratedin a few (Figure 2.10). Despite relatively high annual The share of value added from agriculture fell from 19.9 changes in wages in the agriculture sector it still experi- percent of GDP in 2000 to 10.8 percent in 2013 and is ex- enced a decline in employment, reflecting that overall pected to have declined to 10 percent in 2014,11 while the returns are lower compared to other sectors. The increase share of value added from industries increased from 26.5 in construction employment reflects the overall growth to 32.5 percent over the same period. Employment in agri- in the construction sector, especially after the end of the culture declined from 36 to 31 percent between 2000 and conflict. 2012 and increased in industry and services over the same period (Figure 2.11B). It is noteworthy that a major part of 58. There are four potential drivers of the increase in the decline in agricultural employment (and rise in indus- labor incomes and its poverty impacts over the last 10 try) occurred only in 2012, the last year measured. years. The following section focuses on these drivers: (i) There are four a slow structural transfor- 60. The shift toward employment in the industry sector and the expansion in services was associated potential drivers mation away from relatively with increases in productivity. Total factor productiv- of increased labor unproductive agriculture and into industry and ser- ity (TFP) growth accounted for about half of Sri Lanka’s growth over the last decade contributing on average 3¼ incomes: structural vices that led to aggregate percentage points per year, rising to about 3½ percentage transformation, productivity increases; points recently.12 A range of empirical approaches suggest (ii) agglomeration effects agglomeration, around key urban areas; (iii) that potential growth has risen by almost 1 percentage domestic demand and domestic demand growth, food price increases vestment; and (iv) domestic including public-sector in- 11  Central Bank of Sri Lanka, 2015 and international food price 12  IMF 2014. Figure 2.11 Sectoral value added and employment growth A. Sectoral value added (constant 2005 us$) B.Sectoral employment (Index 2000=100) (Index, 2000=100) 240 115 220 110 200 105 180 160 100 140 95 120 90 100 85 80 60 80 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2011 2000 2001 2002 2003 2004 2005 2006 2008 2009 2010 2012 2013 2007 Agriculture Industry Services Agriculture Industry Services Source: World Development Indicators. Source: Own construction using Labor Force Surveys 30 | II. Country Context Figure 2.12 Sectoral productivity 2002-2012 A. Output per worker by sectors B. Decomposition of growth in output per worker 8,000 Inter-sectoral shift 6,000 millions of 2005 Dollars Services 4,000 Industry 2,000 Agriculture 0 Agriculture Industry Services 0% 10% 20% 30% 40% 50% 60% 70% 2002 2012 Contribution to change in output per worker Source: Own estimates using WDI, DCS Labor Force Surveys. Decompositions done using JoGGS decomposition method (see World Bank, 2010) and growth accounting framework following Duma, 2007. point to about 6¾ percent in recent Figure 2.13 Night lights image of Sri lanka, 1975- 2014 years compared to the period 2003–08. This appears to reflect equally capital deepening (through increased invest- ment on infrastructure and equipment) and improved factor productivity, with labor’s contribution broadly un- changed. Most of the increase in pro- ductivity took place within the industry and service sectors (Figure 2.12A), but an inter-sector shift in employment away from agriculture and into indus- try and services also played a role and could partly explain increases in labor incomes (Figure 2.12B). Agglomeration Effects 61. Along with this structural transformation, Sri Lanka has been experiencing a dynamic spatial transformation process of urbaniza- tion and agglomeration in the past two decades. Urbanization13 and ag- 13  According to official estimates, only 15.7 percent of Sri Lanka’s population lives in urban areas, making it the least urbanized country in South Asia and MICs. This is due to the country’s conservative definition of urban as population Note: White areas show stable areas of lighting over the period 1992-2012, whilst red areas show lights which living in ‘town’ and ‘municipal’ administrative existed in 2012, but not in 2002 or 1992. units last demarcated in the 1980s. This does not Source: this map is produced by Chris Small, Columbia University by overlaying the tri-temporal Night Time Light capture Sri Lanka’s level of population agglomer- images of VIIRS and DMSP-OLS imagery ation described here. A 2010 agglomeration in- Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 31 Figure 2.14 Agglomeration and growth A. DSD Contribution to national growth B. Built-up areas and growth 1.6% 3.0% Contribution to national growth, 2001-11 Contribution to national growth 2001-11 1.4% 2.5% 1.2% 1.0% 2.0% 0.8% 1.5% 0.6% 1.0% 0.4% 0.5% 0.2% 0.0% 0.0% 0 50 100 150 200 250 300 350 -0.4% -0.2% 0.0% 0.2% 0.4% 0.6% 0.8% 1.0% 1.2% 1.4% 1.6% -0.2% Ordinal contribution ranking Share of national built up area in 2014 Note: GDP per capita is calculated on the basis of the intensity of night-time lights data. Source: World Bank calculations. glomeration have been occurring in two forms: one is the all growth in Sri Lanka. Satellite imagery on built-up areas prime multi-city agglomeration of Kandy-Colombo-Galle by DSDs can be combined with night-light information to in the Western Province, which is the largest in the coun- see the correlation between built-up areas and growth. try and has also experienced the bulk of the growth. The Not surprisingly, a larger share of built-up areas is posi- second form is a few localized single-city agglomerations tively correlated to national growth measured using night- in the eastern and northern parts of the country, mainly time lights (Figure 2.14B). That is, urbanization and growth around Trincomalee, Batticaloa-Akkaraipattu, and Jaffna. have been moving hand in hand. This spatial transformation process has profound implica- tions for both economic growth and alleviating poverty Increases in Aggregate Demand, including and vulnerability. The agglomeration spawning from the Government Infrastructure Projects Colombo Metropolitan Region along the two corridors to Kandy and Galle/Matara is evolving to become a func- 63. Domestic demand was largely responsible for tional multi-city urban agglomeration. Recent growth, in growth. Private consumption accounted for 67 percent particular, around Colombo, Kandy and Galle, including of GDP in 2013, having expanded by 6 percent a year the corridors that connect those cities, is evident in the red on average between 2002 and 2013 (Figure 2.15A). Pri- lighting in Figure 2.13, which represents night-time lights vate investment, on the other hand, accounted for 23 per- that were present in 2012 but not in 2002 or 1992. cent of GDP in 2013, after an average growth of 9 percent a year during the same time period. In addition, public infra- 62. Agglomeration may have been fueling growth structure spending grew at an average rate of 18 percent and partly determining national performance. Eco- a year between 2002 and 2013, and made up 6 percent of nomic growth in Sri Lanka has been partly driven by GDP by 2013 (Figure 2.15B). The impulse coming from ex- highly built-up areas. Using night-time lights data as a ports, on the other hand, was very small, with an average proxy for GDP for the 2001-2011 period shows that a small growth rate of 4 percent a year, so that the contribution number of regions are responsible for a larger share of of exports to aggregate demand declined from 35 to 26 national growth. In fact, 10 percent of Divisional Secretar- percent of GDP between 2002 and 2013. iat Divisions (DSDs) contributed nearly 30 percent of the country’s growth over the period (Figure 2.14A). Further- Increased Commodity Prices more, only 20 percent of DSDs contributed almost half of 64. Higher real wages, especially in agriculture, played a key role in reducing poverty. Although ag- dex which takes into consideration features associated with urbanization riculture is no longer a major contributor to growth (ac- calculated that Sri Lanka a 47 percent rate of agglomeration. counting for under 11 percent of GDP), around one-third 32 | II. Country Context Figure 2.15 Growth in aggregate demand A. Composition of aggregate demand B. Growth in demand components (percent of GDP) (index, 2002=100) 150 600 500 100 400 50 300 200 0 100 -50 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Private consumption Government consumption Private consumption Government consumption Government investment Private investment Government investment Private investment Change in stocks Exports Change in stocks Exports Imports Imports Source: World Development Indicators and Central Bank of Sri Lanka. of the population still remains engaged in, and dependent a year since 1980 and lags behind other South and East on, agriculture. Real wage growth in the agriculture sec- Asian countries, although it may have picked up recent- tor averaged 5.7 percent annually from 2006 to 2012/13, ly. TFP growth contributed only 53 percent to overall out- causing poverty to fall more rapidly among self-employed put growth while a large share of the agricultural output farmers and agricultural workers, ahead of workers in oth- growth was achieved through the expansion of arable er sectors. Wages in the industrial sector increased by 3.6 land that will not be sustainable in the longer term. percent annually, while wages in the service sector grew by 3.1 percent on average, led by trade (4.6 percent) and transportation (6.0 percent) Figure 2.16 Poverty rates fell most rapidly among workers in agriculture (Figure 2.16). During the same time, the share of workers in agriculture continued to decline by 1.3 percentage points, from 32 to 30.7 per- 30% 26 cent, with young workers shifting out of ag- riculture more quickly. Minimum agriculture 25% 20 21 Povery rate by sector wages for employed farm workers rose con- 20% siderably between 2009 and 2012, which may 14 14 have also pushed up real agriculture wages. 15% 11 9 10 10% 8 65. Productivity growth in agriculture 5 6 has been slow and does not sufficiently 5% 3 explain agricultural wage growth. Agri- 0% cultural GDP per hectare of arable land grew by only 3.5 percent between 2000 and 2011, 2002 2006/07 2009/10 2012/13 compared to 26 percent in Indonesia, 35 per- cent in the Philippines, and 61 percent in Ban- Industry Services Agriculture gladesh. Labor productivity has also fallen behind South-Asian comparators. Agriculture TFP growth, measuring technological prog- Note: GDP per capita is calculated on the basis of the intensity of night-time lights data. ress, grew only by an average of 0.6 percent Source: World Bank 2015 Poverty Assesment (forthcoming). Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 33 Figure 2.17 Wages by sector A. Composition of Aggregate Demand B. Real Wage Index (percent of GDP) (Index, 2002=100) 150 150 Real wage rate indiex (1978 base) 120 Real wage indexc (2002=100) 130 90 110 60 90 30 0 70 2004 2006 2008 2010 2012 2011 2002 2003 2004 2005 2006 2007 2008 2009 2010 2012 Agriculture Services Agriculture Industry and Commerce Services Industry and Commerce Wage board trades Source: World Bank Poverty Assessment 2015. 66. In contrast, rising domestic and international hicle registrations. Domestic trade (11.1 percent), import food prices may have provided space for the increase trade (7.8 percent) and financial services (8.2 percent) were in the agricultural minimum wage and corresponding the other main contributors increases in agricultural wages. Rising food prices, par- to growth. Less prominent ticularly from 2006 to 2009, provided additional profits were the agriculture sec- The top four sectors to agricultural producers In addition, international prices tors. These sectors contrib- contributing up to for tea rose more than 50 percent, from $2.1 to $3.3 per uted to 5.3 percent of the growth while all other man- 50 percent of total kg between 2006 and 2009. This occurred despite little change in yields. The increase in the price for tea provid- ufacturing/service sectors growth were all non- ed space for increasing the real minimum wage for agri- collectively accounted for tradable sectors cultural workers (Figure 2.17A), although they continue to 44.7 percent of the growth. be lower than wages in industry and services. Agricultural Moreover, Sri Lanka’s share wages, unlike those for industrial and service sector wag- of manufacturing output, which was 18.7 percent in 2000, es, tracked these minimum wage increases almost exactly rose to 19.5 percent in 2005 and declined to 17.2 percent (Figure 2.17B). by 2014 due to faster growth in the services sector. 68. Reliance on non-tradable sectors for growth D. Macroeconomic Challenges to could make it difficult to sustain the momentum in the Poverty Reduction and Shared long run. While data is lacking on the breakdown between private- and public-sector involvement across industries, Prosperity there is strong indication that public investment to rebuild following the end of conflict is responsible for much of the 67. Recent growth has been mainly led by the proportionately large growth in construction as well as non-tradable sectors. Sri Lanka’s real GDP grew by 43 per- transport (which is inclusive of some transport infrastruc- cent from 2009 to 2014. The top four sectors contributing ture). It would appear unlikely that these sectors would to 50 percent of the total growth during the period were underpin sustained growth going into the future owing to all non-tradable sectors: construction, transport, domestic fiscal space limitations as well as a decline in the need for trade and banking, and insurance and real estate (Figure post-conflict reconstruction. More generally, construction 2.18). Reflecting the intensity of a needed post-conflict in- and transport infrastructure are not likely to be sources of frastructure development thrust, the construction sector sustained, consistent growth. alone contributed to 16.8 percent of the total growth while growing by 109 percent in real terms. The transport sector 69. In contrast, there has been a steady decline in contributed to 14 percent of the total growth, reflecting commodity exports. Before 1977, Sri Lanka’s develop- improved transportation infrastructure and increased ve- ment strategy, based on import substitution, aimed to 34 | II. Country Context Figure 2.18 Sectoral growth patterns Post confict growth map - A sectoral perspective 2009-2014 20.0% 18.0% 16.0% Construction, 10% Transport, 12% Contribution to growth 2009-2014 14.0% Agriculture 12.0% Domestic Trade, 11% Industry 10.0% Import Trade, 8% Services 8.0% Banking, Insurance & Real Estate , 9% Food, Beverages, Tobacco, 7% 6.0% Mining & Quarrying, 3% Textile and Leather, 4% 4.0% Chemical, Petroleum, Coal, Rubber & Other Food Crops, 4% Plastics, 3% Hotels & Restaurants (growth 190%), Export Trade, 4% Post &Telecom, 2% 1% 2.0% Others, 2% Electricity, 2% Tea, 1% Cottage Industry Fishing, 1% Minor Export Crops 0% Agri Processing Livestock Ports & Aviation, 1% Rubber, 0% 0.0% Firewood & Forestry Plantation Development -40% -20% Paddy, 1% 20% 40% 60% 80% 100% 120% -2.0% Post-war growth 2009-2014 Note: Bubble Size corresponds to size of segment Source: World Bank 2014a, based on Central Bank of Sri Lanka. create a comprehensive welfare state. Post-1977, reforms economies and leveraging existing industries to move up aimed to liberalize the foreign trade regime and Sri Lanka the value chain as well as fostering the development of was seen as the first country in South Asia to significantly open its borders to trade and foreign direct investment. Figure 2.19 Steady decline in trade In the decades that followed, trade of goods and services increased to 89 percent of GDP in 2000, with tea and high- end apparel exports leading 100% 0.09% Since 2000 trade the way (Figure 2.19). How- 90% 0.08% steadily declined, the new millennium, trade ever, after the beginning of 0.07% reaching 54 percent steadily declined reaching 80% 0.06% of GDP in 2013 54 percent of GDP in 2013. 70% 0.05% FDI remains below 2 percent 0.04% of GDP five years after the end of armed conflict. The decline in openness and stag- 60% 0.03% nating FDI took place when the rest of the world was inte- 0.02% 50% Exports + imports (%GDP, left axis) grating more strongly and global trade was accelerating. Exports of G & S (% world market, right axis) 0.01% Sri Lanka’s world market share has consequently declined to levels last seen in the 1980s. 40% 0.00% 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 70. Moreover, the configuration of production in Sri Lanka has remained largely constant in the last three decades. At the same time some MIC comparators, like Source: World Development Indicators, January 2015; Central Bank of Sri Lanka, Staff Thailand, have been highly successful at diversifying their estimates Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 35 Figure 2.20 Product space comparison: Sri Lanka vs Thailand in 1980 & 2009 Product space in Sri Lanka, 1980 Product space in Thailand, 1980 Product space in Sri Lanka, 2009 Product space in Thailand, 2009 Source: MIT Media Lab–Macro Connections and Harvard University–Center for International Development n.d. new industries. Figure 2.20 shows a comparative develop- 71. While the trade deficit has recently improved, Sri ment of the product space14 of Sri Lanka and Thailand over Lankan exports face structural challenges. In particu- the same period. Sri Lanka experienced a rather limited lar, the tradable sectors are facing rising production costs, growth of economic activities adjacent to existing indus- particularly for Sri Lanka’s main agricultural exports (tea tries; lower development of new industries; and exporting and rubber).15 Similarly, although garment exports have sectors remained at the periphery of the economy. In con- increased in nominal terms and there has been movement trast, Thailand had a similar export structure to Sri Lanka in to higher added-value production, the share of garment 1980 but a much different one by 2009. Thailand now has exports relative to GDP has continuously declined. Weaker much lower activity in resource-based and labor-intensive external demand from the European Union (EU) and the exports and instead has dense clusters in electronics, mi- United States and rising relative labor costs has also affect- crocircuits and machinery. 15  This has always been an issue as plantation workers (tea and rubber) 14  Product Space Analysis helps to illuminate the relationship between have historically been very well organized under political leadership of diversification and economic growth. It measures the distance between the Ceylon Workers Congress. Their strong bargaining power has driven a pair of products based on the probability that they are exported by the a wedge between wage and productivity trends. Many workers are paid same countries. even if they do not have work. 36 | II. Country Context Figure 2.21 Steady decline in trade 74. On the fiscal front, low and declining fiscal revenues have become a key macro-economic concern for Sri 20 60 Lanka. The tax revenue-to-GDP ratio, which amounted to 24.2 percent in 1978, 15 declined to 14.5 percent in 2000 and 40 reached 10.7 percent in 2014 despite an Percent of GDP Percent of GDP 10 annual increase in GDP per capita of 11 percent a year (Figure 2.22). This partly led 20 to large fiscal deficits, particularly before 5 end of conflict, when Sri Lanka averaged deficits of around 7-8 percent of GDP a 0 0 year. Over the past five years, the govern- 2000 2002 2004 2006 2008 2010 2012 2014 ment has made an effort towards fiscal consolidation, reducing the budget deficit from 9.9 percent in 2009 to 6 percent in Current account deficit (left hand side) Exports (right hand side) 2014. Trade deficit (left hand side) Imports (right hand side) 75. Despite fiscal consolidation efforts, Sri Lanka continues to face Source: World Development Indicators, January 2015; Central Bank of Sri Lanka, staff estimates public debt risks. Although much im- proved from earlier years where the debt ed garment exporters. Productivity growth in tea has been stock was over 100 percent of GDP, public debt stood at stagnant, and the sector has been challenged by drought 75.5 percent of GDP at end-2014, posing macroeconomic and lower demand from the Middle East. risks if growth slows in coming years. Increases in current spending in 2015 have been offset with one-time revenue 72. Pressure on Sri Lanka’s balance of payments measures, implying long-term revenue streams will be re- caused by persistent trade deficits has been offset quired (see Chapter III for detailed discussion). The compo- partially by strong remittance inflows and a growing sition of debt is also changing, moving from concessional role for tourism. Collectively, remittances and tourism in- lending to shorter-term commercial borrowings. Howev- creased from 8.5 percent in 2000 to 12.4 percent of GDP in er, during 2014 there has been a systematic conversion of 2014 (Figure 2.21). Remittances alone grew from 7 percent short term T-bill issuance into longer term T-bonds, while to 9.5 percent of GDP during the same period. On average, foreign holdings of T-bills and bonds have been contained these two sources covered 92 percent of the trade deficit from 2000 to 2013, and were able to cover the entire trade deficit in 2014. The cur- Figure 2.22 Fiscal performance of Sri Lanka rent account deficit declined from 7.8 percent of GDP in 2011 to 2.7 percent of GDP in 2014. 40 73. The current account deficit has been fi- nanced mostly by external borrowing, rather 30 than through FDI. Much of this external bor- rowing by the public and private sectors went Percent of GDP 20 to finance the country’s rebuilding following the end of the conflict. Despite this borrowing to cover current account deficits, Sri Lanka has 10 been able to reduce its debt to GDP ratio in the past five years thanks to fast growth, relatively 0 low real interest rates and a stable exchange 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 rate. This also shows where the risks are: a slow- down in growth, increasingly commercial terms on new borrowing, and exchange rate volatility Expenditure/GDP Tax/GDP Total revenue/GDP may reverse the decline in the level of external debt-to-GDP. Source: World Economic Outlook, Central Bank of Sri Lanka Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 37 at 12.5 percent of the outstanding value (Central Bank, 78. This diagnostic is based on a systematic and 2015). About 44 percent of the public debt stock is exter- detailed review of key potential factors impacting nal, so that exchange rate fluctuations and any rupee de- progress on the twin goals. In order to identify these preciation could risk deteriorating the debt indicators. constraints we used a hybrid framework that combines the Hausman, Rodrik and Velasco (2005) growth diag- 76. More generally, twin deficits in the fiscal and nostics methodology with the Bussolo and Lopez-Calva current accounts are mirrored by low national sav- (2014) assets-based framework as detailed in Appendix ings, with a persistent savings-investment gap being 1.4. The framework was used as a way to organize and financed mostly through debt-creating flows over the discipline the analysis by identifying a broad range of 22 last decade. National savings has averaged about 25 per- areas where there were possible constraints to, or drivers cent of GDP since 2010, while national investment was as of, progress on the twin goals. Sri Lanka’s performance high as 31 percent of GDP.16 Most of this gap has been cov- in each area was assessed and weighed for their relative ered by debt-creating flows, as opposed to FDI over the impact on achieving the twin goals. This preliminary sys- last decade. Despite strong GDP growth, the external debt tematic analysis was then presented in a set of detailed amounted to about 57 percent of GDP at end-2014. consultations with multiple stakeholders, including gov- ernment, academia, think tanks, the private sector, civil E. Identifying Drivers and society organizations, and international organizations to Constraints to Poverty Reduction validate the findings, determine the relative importance of issues identified in each of the 22 areas, and identify and Shared Prosperity knowledge gaps. 77. The context outlined in this section sets the 79. Discussion around the preliminary analysis and stage for a systematic diagnostic of drivers and con- ensuing consultations led to a consensus around four straints to poverty reduction and shared prosperity major themes, which form the basis for organizing this going forward. Sri Lanka’s political, social, and economic report and the major challenges to progress along the features are the result of a wide variety of factors. These twin goals. The themes are: (i) Fiscal sustainability and the same factors, particularly the more proximate factors that need to ensure fiscal space for development; (ii) Fostering are in effect at present, are expected to drive or constrain growth and jobs for the bottom 40 percent; and (iii) ensur- continued progress on the twin goals of poverty reduc- ing spatial and social inclusion. The fourth major theme – tion and shared prosperity. At the same time, there are the importance of more effective and efficient governance new trends and emerging opportunities that will also – is a cross-cutting issue in all three chapters, reflecting the play a role in shaping Sri Lanka’s development trajectory critical roles of public-sector management, government’s in the coming years. The goal of this SCD is to take stock interface with the private sector, and governance’s impact of these factors, identify their relative importance, and set on inclusion. These four major themes were recurrent in out what would therefore be priorities to be addressed in discussions with multiple stakeholders in terms of the se- order to end extreme poverty and promote shared pros- verity of constraints they pose for achieving the twin goals perity. The SCD focuses on drivers and constraints of prog- of ending poverty and promoting shared prosperity. The ress in the next five years, corresponding to the term of next three chapters describe each of these themes and the new government to be formed after elections in the discuss the priority areas. Those are followed by a chapter summer of 2015. on economic, social and environmental sustainability con- cerns, which are also critical in achieving the twin goals. The final chapter summarizes the main findings and pro- 16  IMF Country Report No. 14/285. vides conclusions. 38 | II. Country Context III. ADDRESSING THE FISCAL CHALLENGE Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 39 KEY PRIORITIES IN ADDRESSING THE FISCAL CHALLENGE ■■ Maintaining continued commitment to fiscal sustainability will require long-term revenue measures. ■■ Simplifying the tax regime and improving tax administration to increase the tax base could reverse the declining revenue trend. ■■ Low revenues and rigidity in expenditures undercut investment in human development while higher levels of financing and effectiveness thereof are needed to meet Sri Lanka’s needs as it transitions to a MIC. ■■ Inefficiencies in social protection and management of the public service particularly undermine efficient use of resources. The Challenge of Sustaining Fiscal 82. Honoring commitments initiated in 2015 while maintaining continued commitment to fiscal sustain- Discipline ability will require measures to secure long-term rev- enue increases. Fiscal debt 80. Sri Lanka’s government has demonstrated a sustainability analysis has strong commitment to fiscal consolidation in the re- shown that slower-than-pro- Long term increases cent past. In the decade before end of conflict, the coun- jected growth, higher prima- in revenue will be ry deficits, or higher borrow- ing costs could quickly lead needed to reduce try averaged fiscal deficits of around 7-8 percent. However, over the past five years, the government has trimmed bud- get deficits each year, going from 9.9 percent in 2009 to an to sustainability concerns. the fiscal deficit and estimated 5.7 percent in 2014. The public debt, which was With public debt amount- ing to 76 percent of GDP at public debt hovering around 106 percent of GDP in 2002, was reduced to 75.5 percent of GDP by 2014. Moreover, the government end-2014, continued com- has committed to reduce the fiscal deficit to 3.8 percent mitment to fiscal consolidation is critical. Reflecting the of GDP by 2017 and public debt to 60 percent of GDP by government’s commitment to sustainability, the budget- ed fiscal deficit is expected to narrow in 2015. However, 2020. With the exception of a spike in 2009 linked to mas- increases in recurrent expenditures are to be financed by sive recovery and rehabilitation needs immediately after one-time taxes, ambitious revenue targets for existing tax- the war’s end, this has been achieved by reducing govern- es, and cuts in public investment, leaving very little room ment expenditures. to maneuver. Moreover, recurrent spending increases on 81. This overall strong performance masks four structural weaknesses in the govern- Figure 3.1 Revenue and expenditure trends ment’s fiscal position: low, declining fiscal revenues; increasing rigidity of expendi- tures; insufficient spending on key public 40 goods and services, particularly for human development; and inefficiencies in the pub- 30 Percent of GDP lic sector. Preserving fiscal balance will become increasingly challenging owing to an extremely low revenue base combined with long-term-ex- 20 penditure commitments including a relatively large public service. If current trends continue, 10 the government will have limited fiscal space to facilitate development. At the same time, 0 experience of regional and MIC comparators 1980 1983 1986 1989 1992 1995 1998 2001 2004 2010 2013 1977 2007 suggests that Sri Lanka is not investing enough in human development. The country’s past suc- cess in these areas cannot be expected to con- Tax/GDP Total revenue/GDP tinue without significant increases in spending, which in turn requires greater fiscal space. Source: World Economic Outlook, Central Bank of Sri Lanka 40 | III. Addressing the Fiscal Challenge Figure 3.2 Revenue performance of Sri Lanka A. Actual Revenue Performance Has Disappointed B. Tax Collection Peer Comparison 16 28 15 23 Percent of GDP Percent of GDP 14 18 13 12 13 11 8 2009 2010 2011 2012 2013 2014 2015 2016 2017 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2010 2011 2012 Bangladesh Philippines Indonesia India Thailand Malaysia 2013 2014 2015 Korea Cambodia Sri Lanka Actual Vietnam Source: World Economic Outlook, Central Bank of Sri Lanka wages and transfers initiated in 2015 will need to be sus- 84. Indirect taxes account for 80 percent of Sri Lan- tained once the one-time revenue measures expire. Given ka’s tax revenue. The country has lower-than-expected government plans to increase expenditures on education revenues from taxes on income, profits, or capital (direct and health from their present low levels, long-term in- taxes) and higher collections from international trade and creases in revenue will be needed in order to reduce the from good and services (indirect taxes) than its peers, fiscal deficit and public debt. both as a share of total revenues and as a share of GDP18 (Figure 3.3). The dependency on indirect taxes, -- mostly VAT, excise and customs revenue – limits the country’s ca- A. Low and Declining Fiscal Revenues pabilities to expand the tax base and raises issues regard- ing the equity of the system and how the tax burden is 83. Sri Lanka now has one of the lowest tax reve- distributed among social groups. nue-to-GDP ratios in the world, and it has been declin- ing for decades. The country’s tax revenue-to-GDP ratio 85. The decline in tax amounted to 24.2 percent in 1978, after which it declined revenue can be traced The decline in to 14.5 percent in 2000 and to 11.6 percent in 2013 (Figure 3.1). The decline is in large part a reflection of Sri Lanka’s to trade liberalization, shortcomings in recent tax-revenue-to- strong GDP growth17 with revenues increasing in abso- tax reforms, numerous GDP tracks with the lute terms. Nonetheless, the fact that revenues have not exemptions, and difficult decline in VAT kept pace with economic growth and barely kept pace tax administration.19 First, with inflation in absolute terms is a continuing constraint trade liberalization and a on the budget. The government has signaled the need to gradual reduction of external trade taxation have low- reverse this trend in recent budgets, each year planning ered tax revenues from international trade. This effect for a significant improvement in the tax revenue-to-GDP was exacerbated by measures introduced in 2012 to curb ratio over the medium term. However, projections of rev- imports (see Chapter IV for a detailed discussion of trade enue increases have consistently failed to materialize (Fig- policies). Second, tax reforms initiated in 2011 streamlined ure 3.2A). In comparison, most of the other South Asian import taxes, unified VAT rates, and abolished some “nui- countries as well as middle-income countries have seen sance” taxes to improve the transparency and efficiency modest improvements in tax collection in the recent past. (Figure 3.2B). 18  Collectively, these taxes accounted for 77 percent of the total tax revenue in 2013 whilst income taxes and telecommunication levy con- 17  During the period 2000 to 2013, the per capita GDP grew from USD tributed to 20 and three percent of tax revenues respectively. 869 to 3280 at 11 percent annually. 19  IMF (2014a and (2014b). Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 41 Figure 3.3 Tax composition in South Asia A. Tax composition in South Asia B. Tax composition in Sri Lanka (percent of total) (percent of total) 100% 80% 14% 19% 60% 8% 40% 9% 20% 25% 0% Maldives Sri Lanka Nepal Bangladesh Afghanistan Pakistan India Bhutan* 25% Income Tax VAT or GST Other Customs Levy Income G&S Trade Other Excise Tax Import Duty Other Taxes C. Taxes on income, profits, capital, 2012 D. Taxes on trade, 2012 (percent of revenue) (percent of revenue) 40 60 INDIA MALAYSIA Taxes on Income/Profits/Capital (% of Revenue) Taxes on Intern. Trade (% of Revenue) 30 40 INDONESIA THAILAND SINGAPORE KOREA 20 SRI LANKA PAKISTAN INDIA 20 SRI LANKA 10 PAKISTAN THAILAND KOREA MALAYSIA INDONESIA 0 0 4 6 8 10 12 4 6 8 10 12 ln GDP per capita (current USD) ln GDP per capita (current USD) *2011 data except Bhutan which is 2009. Sources: IMF FAD Database, MoF Annual Report, 2012; World Bank (2014) of the tax system. However, the unification of the VAT was 2004 to 25 percent in 2013, while the decline in the tax-to- at a lower rate, and corporate and income tax rates were GDP ratio broadly tracks that of the decline in the VAT-to- lowered without a commensurate broadening of the tax GDP ratio (Figure 3.4). VAT collection is weak at 2.9 percent base. Third, the authorities have introduced numerous tax of GDP in 2013 with a c-efficiency20 of 25 percent, which exemptions and holidays to boost foreign investment or is roughly half of the c-efficiency for lower middle-income support specific activities, resulting in an erosion of the tax countries. Domestic-based consumption taxes have re- base (see below). Finally, tax exemptions have made tax mained at the same share over time, while there has been administration more difficult, discouraged tax compliance, a marginal increase in import-based taxes, excise taxes, trade taxes, and the Nation Building Tax (NBT), a cascading and created demand for new exemptions. 86. A decline in VAT collection is the main driver of tax-revenue-to GDP reduction in recent years. The VAT’s 20  “C-efficiency” is the tax collection as a share of the tax base divided share in total revenue has declined from 43 percent in by the tax rate. See Ebrill, 2001 and Keen, 2013. 42 | III. Addressing the Fiscal Challenge Figure 3.4 Trend in tax-to-GDP and drivers of changes 10 16 Income Tax 13.5 8 14 License and others 6 11.6 12 Contributions to change in GDP 4 VAT - Import 2 10 Percent of GDP Import based (other) 0 8 -2 Domestic consumption 6 (other) -4 5.8 4 VAT - Domestic -6 2.9 Tax share of GDP -8 2 (RHS) -10 0 VAT share of GDP (RHS) 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Ministry of Finance, staff calculations indirect tax using a similar base to the VAT, as a share of to- tation of staff, which results in the downgrading of special- tal revenue. On the other hand, the share of the corporate ized skills in tax administration. With regard to tax policy, income tax collection increased, as did the “special taxes,” there is significant influence and overlap from agencies such as the Social Responsibility Levy (SRL) and devolved other than the tax authori- duties to Provincial Councils. ties (e.g. Board of Investment - BOI), which frequently Tax administration 87. Sri Lanka’s low tax revenues are caused primarily grant tax exemptions that is complex and by problems with tax administration allowing for weak further undermine revenue inefficient compliance. The country ranks 158th out of 189 countries administration capabilities. in paying taxes due to the high number of payments (47), There is limited data sharing time taken (167 hours per year) and tax rate (55.6 percent between the Customs and IRD, but not among other enti- of profits), according to Doing Business 2015 Report. A ties, although reforms are planned to overcome this issue. 2013 Public Expenditure and Financial Accountability re- 89. Tax administration is complex and inefficient, port similarly identifies weaknesses in Sri Lanka’s tax ad- though increased use of IT expected in the near future ministration, particularly indicators for collection of gross may lead to improvement over the medium term. At tax in arrears, clarity and comprehensives of tax liabilities present, the system relies heavily on self-reporting for di- and effectiveness of penalties on non-compliance (Figure rect taxes and there is a lack of regulations covering pen- 3.5). alties for non–compliance with registration requirements 88. There are multiple institutions involved with tax for the corporate income tax. Monitoring compliance is administration. Under the MoF, there are three agencies split by type of tax and customer segment within the IRD. In November 2015 the IRD plans to launch the first phase involved in tax collection, including the Department of of a Revenue Administration Management Information Customs, Department of Excise and the Inland Revenue System, which is designed to enable information sharing, Department (IRD), with the latter collecting less than 50 integrate taxpayer information from 22 government insti- percent of total government revenues.21 There is high ro- tutions, and provide for online tax filing for the first time. Other countries, notably Sri Lanka’s neighbor India, have been able to improve administration in recent years large- 21  In 2012, the IRD collected Rs. 443,455 which was 44.9 percent of to- ly thanks to IT improvements. Yet, global experience also tal government revenue according to the IRD’s 2012 Performance Report. indicates that rolling out such systems and implementing Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 43 Figure 3.5 Public Expensiture and Financial Accountability (PEFA) performance on tax-related indicators 13 (i) Clarity and comprehensiveness of tax liabilities 15 (iii) Frequency of complete accounts 6A 13 (ii) Taxpayer access to information on tax reconciliation between tax assessments, collections, arrears records and receipts by the Treasury. 5 liabilities and administrative procedures. 4B India 3 2C Indonesia 15 (ii) Effectiveness of transfer 13 (iii) Existence and functioning of tax collections to the Treasury by 1 of a tax appeals mechanism. Philippines the revenue administration. D 0 Thailand 15 (i) Collection ratio for gross tax arrears, being Vietnam the percentage of tax arrears at the beginning of a 14 (i) Controls in the taxpayer fiscal year, which was collected during that fiscal year registration system. Sri Lanka (average of the last two fiscal years). 14 (iii) Planning and monitoring of tax 14 (ii) Effectiveness of penalties for audit and fraud investigation programs. non-compliance with registration and declaration obligations Source: World Bank (2013) Note: Numbers are from sequence 28 indicators. Rating from A (highest score) to D (lowest score) them well is complex. Strong management and technical ators Thailand and Malaysia (62nd and 32nd, respectively). capacity within IRD will be required. A 2015 study of the administrative burdens showed a re- duction of 43 hours in the number of hours required for 90. Tax administration relies on self-reporting of corporate tax compliance due to improvements in elec- taxes, which is onerous although there has been recent tronic systems for filing and paying taxes. The number progress. Sri Lanka ranks 158th on ‘paying taxes’ accord- of hours endured by firms in Sri Lanka is now lower than ing to the 2015 Ease of Doing Business rankings. These many peers, but the number of payments remains some- rankings are comparable to South Asian comparators (In- what higher (Table 3.1). dia is 156th and Pakistan is 172nd), but below MIC compar- 91. Sri Lanka also provides a large number of tax Table 3.1 Paying Taxes – Compliance of Corporate privileges, though a tax expenditure analysis to assess Income Tax their fiscal impact has not been carried out. Since the introduction of a VAT in 2002, successive changes in the tax regime have led to an increase from around 200 to over Country No. of hours No of payments 500 types of exemptions for a wide variety of goods. There Sri Lanka 16 5 are also over 40 broad types of exemptions on corporate and personal income tax India 45 2 depending on the source of Thailand 160 2 income and the type of tax- VAT exemptions have payer. In addition to these risen from 200 in Pakistan 40 5 Malaysia 26 2 statutory exemptions, the BOI provides a package of 2002 to over 500 additional tax incentives to Singapore 32 1 investors. While this was partially streamlined with regard Bangladesh 140 5 to income tax exemptions in 2012, the BOI can continue Source: PWC World Bank Paying Taxes 2015 to approve incentives on customs duties, VAT and other border taxes. Finally, additional ad hoc tax regimes are ap- 44 | III. Addressing the Fiscal Challenge Table 3.2 Tax rates (2013) Table 3.3 VAT compared with other countries Country Individual Corporate Indirect Country / Category Average VAT Rate C-Efficiency Bangladesh 25 27.5 15 Sri Lanka 12 25 Cambodia 20 10 Bangladesh 15 23.4 (standard rate) India 33.9 33.9 13 Low-Income 16 38 Indonesia 30 25 10 Lower Middle-Income 13 46.6 Malaysia 26 25 10 Upper Middle-income 15 51.6 Sri Lanka 24 28 12 High Income 20 55.6 Thailand 35 23 7 Source: PWC World Bank Paying Taxes 2015 Vietnam 35 25 10 Note: Top rates. Sri Lanka’s individual tax rates range from 4 to 24 percent and corporate tax rates are from 12 to 28 percent, with numerous exemptions and chain of transactions and hence IRD will not detect what special regimes for various payers. Source: KPMG is occurring unless businesses declare the goods and ser- vices. The over 500 exemptions to VAT pose similar disrup- tions and monitoring challenges for IRD. Finally, although plied to entities implementing 13 large projects thus far thresholds for payment of VAT have been raised since last approved under the 2010 Strategic Development Act. An- year, the threshold likely remains too high, given the still nual budgets in recent years regularly include a package small number of VAT-payers (roughly 15,000 registered of new tax incentives targeting specific sectors or types of payers). payers. Tax expenditure analysis is not conducted before or after the introduction of incentives, and statements of tax expenditures are not compiled or published. B. Expenditure Pressures 92. Multiple incentives regimes have also led to co- 94. Low tax revenues combined with an expenditure ordination problems, further undermining effective profile that is effectively non-discretionary has led to administration. Firms have been granted tax incentives a lean, rigid budget. Sri Lanka’s overall revenues and ex- by BOI generally are not monitored by the IRD (with the penditures are among the lowest in the region. There is exception of corporate income tax since 2013) since the little flexibility in the short term on the expenditure side latter does not consider other tax matters related to BOI of the budget. Sixty percent of expenditure in 2013 was investors under its ambit. There has been no formal system on items that the government cannot readily reduce: in- of sharing information between the two agencies, which terest payments, salaries, and transfer payments (Figure further complicates monitoring by IRD. Follow up to en- 3.6). Nearly two-thirds of transfer payments are pensions sure that firms began to pay taxes after tax holidays ended for civil servants, which are a commitment that must be did not occur. met, with the remainder fertilizer subsidies, social protec- tion payments and other transfers. Furthermore, Sri Lanka 93. In contrast, Sri Lanka’s statutory tax rates are has had a large expansion in the number of public ser- comparable to many middle-income countries, though vants in the past 10 years, growing from 646,000 in 2004 to features of policy concerning VAT undercut revenue 1.06 million in 2013, an increase of nearly two-thirds (MoF mobilization because of the administrative burdens 2014). This growth reflects explicit policies to provide pub- that arise. The VAT statutory tax rate is in line with other lic service jobs, especially for university graduates (see be- middle-income countries, while its individual income tax low). These trends will only grow the wage/allowance and rates are somewhat lower and corporate income tax rates pension burdens. are relatively high by international standards (Tables 3.2 and 3.3). Tax policy with regard to VAT includes unusual 95. There is moderate risk in Sri Lanka’s public debt features that create additional administrative burdens. profile. There has been significant accumulation of public In particular, Sri Lanka employs a “simplified VAT” regime debt in recent years, mostly from abroad. Although much whereby significant registered exporters are entitled to improved from earlier years where the debt stock was over purchase goods and services from similarly registered 100 percent of GDP, public debt stood at 75.5 percent of suppliers free of VAT, obviating the need for a refund. En- GDP at end-2014 and could pose macro-economic risks forcing compliance is complicated because there is no if growth moderates in coming years. The composition of Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 45 Figure 3.6. Fiscal indicators A. Revenue, expenditure, deficit/surplus B. Budget rigidity 32 25 30 Government expenditure (% of GDP) 28 India Malaysia 6.7 Vietnam 20 6.1 26 6.0 5.6 Non-discretionary 2.2 5.4 24 Thailand 1.6 15 1.7 1.8 Percent of GDP Korea 22 1.4 Cambodia Hong Kong 20 Sri Lanka Indonesia SAR, China 10 Taiwan, China 18 Philippines 16 Bangladesh Singapore 5 14 12 0 10 15 20 25 2009 2010 2011 2012 2013 Government revenue (% of GDP) Interest payments Wages & salaries Transfer payments Others Surplus Deficit Capex net lending Note: Bubble size corresponds to the size of the deficit/surplus, 2013 data. Source: World Economic Outlook debt is also changing, moving from concessional lending grown fast in the recent years. The outstanding amount to shorter-term commercial borrowings. However, during of Treasury guarantees given to various state and non- 2014 there has been a systematic conversion of short-term state entities to expedite the development work increased T-bill issuance into longer-term T-bonds, while foreign from 1.6 percent to 5.7 percent of GDP from 2006 to holdings of T-bills and bonds have been contained at 12.5 201422, implying an annualized growth rate of 37 percent percent of the outstanding value (Central Bank, 2015). during this period. Moreover, within the mix that has been With about 44 percent of the public debt stock is external, changing over time, the significance of guarantees given exchange rate fluctuations and any rupee depreciation to institutions with stable revenue streams23 declined from could risk deteriorating the debt indicators. 90 percent in 2006 to 40 percent in 2014 while guarantees given to state establishments that are primarily dependent 96. Although the fiscal deficit has been brought on state budget are on the rise24. Monitoring these guar- down, the government’s contingent liabilities have antees is important to strengthen public finances as they could elevate fiscal risks25,26 (Figure 3.7). Figure 3.7 Government guarantees C. Insufficient Spending in Key Areas 15 6 97. Fiscal consolidation and relative prioritization of public investment in capital infrastructure follow- 10 4 Percent of GDP 5 2 22  In order to facilitate guarantees for requiring entities, the ceiling im- posed by Financial Management Responsibility Act No: 3 of 2003 for such contingent liabilities (at 4.5 percent of GDP) was increased to 7.0 percent by way of an amendment in 2013. 0 0 23  Primarily Ceylon Petroleum Corporation (CPC) and Ceylon Electric- 2011 2006 2007 2008 2009 2010 2012 2013 ity Board (CEB) 24  These include Road Development Authority, Kotalawala Defense University, Urban Development Authority Fiscal deficit (% of GDP) 25  Fiscal Adjustment in an Uncertain World, Fiscal Monitor, IMF, April Outstanding guarantees (% of GDP)(RHS) 2013. 26  Often comparable estimates are not available due to existence of Source: Ministry of Finance and Treasury various forms of contingent liabilities (IMF 2005). 46 | III. Addressing the Fiscal Challenge Figure 3.8 Health and education expenditures (share of GDP) A. Sri Lanka. General government expenditures (share of GDP) B. Sri Lanka and regional comparator countries 3.0 8 Thailand Education expenditure ( percent of GDP) 7 2.5 Vietnam 6 Malaysia Percent of GDP 2.0 Korea 5 1.5 4 Indonesia Singapore India 1.0 3 Cambodia Philippines Bangladesh 2 0.5 Sri Lanka 1 - 0 2011 2001 2000 2002 2003 2004 2005 2006 2007 2008 2009 2010 2012 2013 2014 (Es) 0 1 2 3 4 5 Education Health Health expenditure, public (% of GDP) Source: Central Bank of Sri Lanka. Includes central and provincial government spending. ing the conflict have squeezed expenditure on other mostly represent better-off households, the poverty re- public goods, especially with regard to human capital. duction impact of these transfers is limited. Most notably, General government spending on education fell from 2.7 there was no increase until to 1.8 percent of GDP be- 2013 in absolute expendi- tures on the major anti-pov- Social transfers have Spending levels on tween 2006 and 2013, while spending on health fell from erty Samurdhi (“Prosperi- not kept pace with education and health 2 to 1.4 percent of GDP over ty”) program, an integrated GDP growth are low relative to the same period, though welfare program providing other middle income estimates for 2014 show a significant rebound (Figure cash transfers, housing assis- tance, subsidized kerosene and assistance to pregnant and countries 3.8A). These levels are low lactating mothers set up in 1994. Despite a small increase, relative to other middle-in- only 0.22 percent of GDP was spent on anti-poverty and di- come countries (Figure 3.8B), particularly given the rising saster relief programs. New cash transfer programs for the costs of healthcare associated with an aging population. elderly and the disabled have been introduced but these Moreover, Sri Lanka faces increasing demands for a more amounted to only 0.03 percent of GDP in 2013. skilled workforce to be able to compete globally while meeting the aspirations of the youth, as described in the 99. Low levels of public spending may undercut Sri next two chapters. Lanka’s past strong gains in human development and leave it less well equipped to face changing human de- 98. Sri Lanka’s expenditure on social protection pro- velopment needs as a MIC. For decades Sri Lanka outper- grams has also declined steadily in recent years. The formed other lower-income countries in making steady total amount of transfers has increased in absolute terms improvement on human development outcomes, such as over the past decade, but has not kept pace with GDP life expectancy, maternal health and educational enroll- growth (Figure 3.9A). In 2013 two-thirds of social welfare ment (see Appendix 1.1 on achievement of the MDGs). It programs went to social transfers, while the remaining is much closer to average in outcomes when compared to third was spent on health and education programs, vari- other lower middle-income countries LMICs. Sustaining ous subsidies, and absorbed losses of SOEs (primarily the progress will involve addressing different types of chal- Railways, Postal Service and Transport Board) (Figure 3.9B). lenges more typical of a MIC. For instance, whereas Sri Lan- Moreover, growth in absolute terms has been driven by a ka excelled in addressing communicable diseases in the significant increase in pensions and to a lesser extent, fer- past, it now faces a bigger problem with non-communica- tilizer subsidies. Because Sri Lanka’s state pension system ble diseases reflecting an aging, more urban, and affluent only encompasses public servants and the military, which population. Similarly, the changing economy is placing Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 47 Figure 3.9 Social protection expenditures are insufficient and inefficient (share of GDP) A. Social protection expenditure B.Decomposition of expenditure on social welfare 2000-2013 programs, 2013 250 4.5% 0.03% 0.11% 200 4.0% 3.5% 0.34% Public Sector Percent of GDP 150 Pensions Social Transfers 1.42 percent LKR Bn 3.0% 0.18% 1.85 percent 100 2.5% 0.44% 0.18% 0.03% 50 0.21% 2.0% 0.02% 0 1.5% Subsidies SOE operational losses 2000 2002 2004 2006 2008 2010 2012 Health & nutrition programs Education programs Other welfare Public sector pensions Samurdhi Pensions Samurdhi Other pro-poor cash transfers Fertilizer Others Military benefits Disaster relief Source: Ministry of Finance and Treasury Source: Ministry of Finance and Treasury greater demands for a more skilled workforce, whereas Sri will place further demands for more, cost-effective infra- Lanka’s tertiary education has enrollment rates below the structure, particularly power. LMIC and South and West Asian averages (a discussion of tertiary educational needs is in Section IV). 101. In the past, the pressures on financing capital investment were eased by waves of concessionary do- 100. Sri Lanka will also need to finance infrastructure nor funding that will not continue because Sri Lanka needs to keep pace with increasing demand. Sri Lan- has reached middle-income status. Consequent to a ka’s infrastructure compares favorably to its South Asian deteriorating security situation and political instability, neighbors in terms of accessibility, and the past five years the international donor community substantially limited have seen a major expansion of public investment in infra- official development assistant (ODA) to Sri Lanka through- structure (see Appendix 2.1 for a more detailed review on access and management issues for various infrastructure Figure 3.10 Usage patterns of vehicles, 1960-2030 sectors). In particular, over the past five years, the govern- ment has invested about 4.4 percent of its total expendi- tures (outside of interest payments) in infrastructure in the Northern Province alone in order to redress imbalances.27 However, Sri Lanka’s needed investment remains high in order to keep pace with the changes underway in the country. In particular, increasing urbanization will require more sophisticated infrastructure to maximize benefits from agglomeration, provide for livability, and avoid con- gestion. With greater affluence will come increased use of individual vehicles, currently growing at 10 percent a year and set to displace the modal share of public transport if demand management measures and public transport development are not addressed (Figure 3.10). Structural transformation that has underpinned productivity growth 27  Ministry of Finance, 2014 Source: World Economic Outlook, Central Bank of Sri Lanka 48 | III. Addressing the Fiscal Challenge out the 1990s. Donor aid surged following the signing of a the population over 65 drew a pension in 2013. Expanded ceasefire between the government and LTTE in 2002 and subsidies for fertilizer are available to all farmers (with dif- again following the Indian Ocean tsunami in December ferentiation in the amount of subsidy depending on the 2004. The combined effect of these was that ODA to Sri crop); it can be argued in only the most general terms that Lanka rose from US$330 million (2 percent of GDP) in 1999 these farmers are relatively likely to be poor. to $1.33 billion (5 percent of GDP) in 2005 – comprising the highest level of aid to the country. Despite complica- 104. Anti-poverty programs suffer from poor target- tions in disbursing post-tsunami aid in conflict areas due ing. In fact, analysis of the HIES shows that if it were possi- to the lack of full government control there, social and ble to perfectly target individuals below the poverty line, connective- infrastructure needs (roads particularly) in the the amount needed to bring all poor individuals to the East and also in the deep South of the country were met poverty line would have been only 0.12 percent of GDP in by generous donor funds, easing the pressure on public 2013. Programs rely on manual registration and identifica- funds. Given that Sri Lanka has achieved middle-income tion, and lack a capability to actively search for excluded status, this level of funding is not likely to materialize go- individuals. Although some programs have categorical el- ing forward, highlighting the imperative for domestic rev- igibility criteria, more than half of Sri Lankans living below enue mobilization. the poverty line receive no benefits from existing social assistance or social welfare programs (though they may 102. Public investment will need to be applied ef- benefit from free health and education). At the same time, fectively to crowd in other sources of financing. Pub- a third of spending on social transfers goes to the richest lic financing will remain important, but it will need to be 60 percent of the population. Samurdhi and School Lunch supplemented by more private sources to address infra- programs transfer nearly the same amount to the bottom structure needs. In- recent years the government increased quintile, and in both cases roughly 55 percent of benefits expenditure on energy, water supply, transport and com- go to the bottom 40 percent. The other three programs, munications from under 11 percent of total spending in when considered as a group, distribute 53 percent of their 2005 to around 20 percent transfers to the bottom 40 percent (Figure 3.11). By tight- Effort should be annually from 2009-13 (or roughly 4 percent of GDP, ex- ening eligibility criteria and making an effort to register the poor for benefits, existing spending could be more ef- undertaken to cept 2009, which had a large fective in combating poverty. leverage public funds fiscal deficit). Although there 105. Fertilizer subsidies have limited impact on the are some exceptions, infra- with private-sector structure was built thanks to poor while creating negative distortions in the agri- investment to address direct public financing. As is culture sector that undermine productivity. Fertilizer infrastructure needs discussed at greater length in the next chapter, effort Figure 3.11 Incidence of social benefits (percentage of should be undertaken to benefits accruing to each quintile) leverage public funds with private-sector investment giv- en the quantum of investment needs going forward. 100% D. Inefficiency in Social Transfers 9.6% 12.2% 80% 13.5% 20.0% 19.1% 15.6% 103. In addition to low levels of spending, Sri Lan- 60% 18.7% ka’s social protection system has limited effectiveness. 26.6% 16.3% 25.0% Some of the programs classified as social transfers should 40% 22.4% not be classified as such.28 Pensions account for most 25.8% transfers, but not surprisingly given the public service 20% 38.8% 38.8% 30.0% background of pensioners, less than half of them are in the 20.2% bottom 40 percent (HIES 2012/13). Less than 30 percent of 0% Samurdhi Fertilizer School Lunch Others Bottom quintile 2nd quintile 28  Although the Ministry of Finance categorizes civil service pensions 3rd quintile 4th quintile Top quintile as part of welfare programs, they are part of total civil service compen- sation rather than a welfare program and cannot be considered a social protection program per se. Moreover, note that the Ministry of Finance refers to SOE losses as part of welfare spending (World Bank, 2014a). Source: World Bank Poverty Assessment 2015 based on HIES 2012/13. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 49 Figure 3.12 Age-gender pyramid A. 2001/2 B. 2012.13 Age-Gender Pyramid, 0102 Age-Gender Pyramid, 1213 95+ 90-94 85-89 80-84 75-79 70-74 65-69 60-64 55-59 50-54 45-49 40-44 35-39 30-34 25-29 20-24 15-19 10-14 5-9 0-4 6 5 4 3 2 1 0 1 2 3 4 5 6 6 5 4 3 2 1 0 1 2 3 4 5 6 Share in total population. % Share in total population. % Share of Males Share of Females Source: HIES subsidies are the least well-targeted transfer, with only 45 107. Pressures on the healthcare system and the so- percent of the benefit being devoted to the bottom 40 cial protection system are expected to grow with an percent (Figure 3.11). Furthermore, these subsidies have aging population. The proportion of the country’s work- distorted market decisions by encouraging cultivation of ing age population (defined as ages 15 to 59 in Sri Lan- certain crops, especially paddy, hindering the movement ka) reached its peak in 2006 and the overall population is to other types of agriculture that have more potential for expected to peak in 2016 (Figure 3.12). The child popula- value addition. Even for targeted crops, these subsidies tion (up to age 14) declined from 35 percent in 1981 to 23 have not prompted productivity increases.29 At the same percent in 2011, while the number of people aged 60 and time, intensive usage of cheap fertilizers lead to environ- above is expected to double in 2041 relative to 2011. Sri mental and potential human health hazards. Thus, sub- Lanka is in the midst of its demographic dividend at pres- sidies negatively affect those in the bottom 40 percent ent and hence there is urgency to “get rich before getting old.” While this fiscal burden may continue to be mitigated engage in agriculture across multiple dimensions, sug- by the limited coverage of pension schemes to public-sec- gesting a need for rationalization. tor workers, Sri Lanka can expect to need to develop pro- 106. Moreover, poverty programs are fragmented. grams for social protection of the elderly. Furthermore, the There are the 11 major anti-poverty programs, including 40 percent increase in the number of civil servants over the Samurdhi, in addition to multiple-agency programs that past 10 years, discussed below, will substantially increase split the already small amount available for welfare pro- the number of pensioners under the current system (see Chapter VI for a detailed discussion of fiscal issues associ- grams. Programs rely on manual registration and identifi- ated with an aging population). cation, and lack a capability to actively search for excluded individuals. They also employ varying eligibility require- ments and administrative structures, and lack modern information management systems that would allow for harmonization among programs. 29  Annual crop productivity figures are from Agriculture and Environ- mental Statistics Division; Department of Census and Statistics, Colombo, Sri Lanka. 50 | III. Addressing the Fiscal Challenge E. Large Public Sector equivalent to the formal wage bill over the past five years. All public servants (and pensioners who receive 50 per- 108. Despite its small fiscal footprint and relative cent of the benefit) receive a cost-of- living allowance that has increased from 1,000 rupees in 2006 to a commitment state effectiveness,30 Sri Lanka’s public sector is large. of 10,000 rupees in 2015. Outside of cost-of-living allow- With over one million employees, public-service employ- ances, there is a wide range of additional allowances and ment exclusive of semi-public incentive payments that vary for different services and entities, accounts for about Public-service 13 percent of the labor force. individual schemes of recruitment. The type, criteria for receipt,and the quantum of allowances are approved by employment Although cross-country com- the MPA’s director general of establishment. For instance, accounts for 13 parisons are difficult owing to different definitions of the preliminary medical officers may receive a base monthly percent of the labor public service, the size of the wage of 26,000 rupees per their grade, but seven addition- al allowances account for an additional 105,000 rupees, as force, close to OECD public sector in Sri Lanka is well as the right to earn more through private practice in higher than comparable pub- levels lic services in Thailand (rough- the evening. Thus, the complement of staff is approved by the DMS, wages are set by the National Pay Commission ly 9 percent) and close to and a varied system of allowances is set by the MPA’s Es- OECD levels (average of 15 percent in 2011). There have tablishment Department. been also small but steady increases in semi-governmen- tal organizations such as SOEs employment over the past 111. Political governments have substantially in- 10 years, comprising a further 239,000 employees in 2013. fluenced the size and operation of the public service. The government from 2005 to 2014 explicitly sought to 109. Human resource management of the public ser- increase public-sector employment, particularly with re- vice is complex with limited controls on the expansion cent graduates through the Yovun Diriya and other pro- of the civil service. Public servants are either recruited to grams.31 Particularly large recruitments were carried out one of 28 island, combined and other services (categories in 2005 and 2012. While recruitment is carried out by an of employees) or are hired in terms of respective service objective process of examination, the higher echelons of minutes and individual schemes of recruitment of specific public service have been subject to influence by political departments or other agencies. The complement of staff governments. Since the 1972 Constitution, all ministry sec- recruited through either route is proposed by the depart- retaries have been directly appointed and removed by the ment/agency and approved by the Department of Man- president. This has led to a small number of high-profile agement Services (DMS) in the Ministry of Finance (MoF). appointments of people without prior civil service expe- Analysis regarding overall staffing needs is therefore ef- rience. It has also meant that with every change of gov- fectively carried out only by the agency in question. While ernment, secretaries cease to hold their positions (and are the MoF through its DMS plays an oversight role, decisions often reassigned to another agency). Other transfers and are made on a case-by-case basis without a holistic view of promotions fall under the PSC, which, in turn, has served managing the size of the overall civil service. Politically im- at the pleasure of the president for almost all of the past portant ministries have demonstrated ability to increase 30 years. This framework is conducive to senior officers de- their staffing complement in recent years. Hiring per the veloping strong political affiliations.32 New constitutional approved cadre schedules is then carried out via the Public amendments are expected to provide for more autonomy Service Commission (PSC) on the basis of examinations. of the civil service through a more independent PSC. 110. There is also fragmented control of remuner- ation. Wage reforms in 2006 led to the consolidation of F. Improving Public Expenditure over 100 various positions to 37 grades and corresponding salaries, which have been occasionally increased by the Management Ministry of Public Administration (MPA) upon recommen- 112. There are additional ways to address the fiscal dation of the National Pay Commission appointed by the challenge through further improvements in a gener- president. There is also an extensive system of allowances ally sound system of public expenditure management. that, in terms of aggregate spending, have been roughly A 2013 PEFA assessment noted relative strengths in terms 30  Sri Lanka’s ranking for Government Effectiveness and Controlling Corruption according to World Governance Indicators has been consis- 31  See Mahinda Chintana, also 2013 budget speech. tently higher than South Asian and LMIC averages over the past 10 years. 32  Transparency International, National Integrity Assessment, 2010. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 51 of budget process, quality of annual financial statements, 115. A weak procurement environment remains a legislative scrutiny, and timeliness and quality of follow up concern, though reforms are imminent. Public pro- on audit findings. At the same time, Sri Lanka scores be- curement expenditure in Sri Lanka is approximately low LMIC averages on several PEFA indicators including: (i) equivalent to 21 percent of total government spending monitoring and reducing payment arrears; (ii) oversight on in 2013, making up over half of total discretionary ex- aggregate fiscal risk; (iii) public access to key fiscal infor- penditures. Despite its importance, there are a number of mation; (iv) tax payer registration and tax collections; (v) institutional issues that undermine efficient procurement. internal audit and payroll controls; (vi) procurement pro- In particular, there is no dedicated oversight and support cedures and transparency; and (vii) predictability in the agency after the abolition of the independent Nation- availability of funds. al Procurement Agency in January 2008 and the transfer of its functions to the MoF’s Public Finance Department. 113. Budget planning and execution practices can Although the government has procurement guidelines, have an adverse effect on sector planning and perfor- manuals and standard documents, there is inconsisten- mance. There is limited linkage between long-term financ- cy internally and in execution. There is no independent ing frameworks and sector plans, with the latter effectively complaints review mechanism for public procurement. lacking cost estimates. During annual budget preparation, Finally, Sri Lanka is yet to take steps to introduce electron- ceilings provided by the MoF ic government procurement, which in other countries in Budget adjustments are often late and do not the region and beyond has made public procurement are effectively carried relate to medium-term fi- nancial plans. In most cases, more economic, efficient and transparent. Within this fluid out through cash sector plans and strategies institutional context, the government has on several oc- casions made high-profile procurements on the basis of rationing which follow an activity-based ex- unsolicited bids, leading to allegations of cost inflation.33 penditure classification that leads to ad hoc is not compatible with the These issues are expected to be addressed through a new national Procurement Commission mandated by the 19th prioritization of administrative and function- Constitutional Amendment, as well as through the pas- expenditures al classification used for bud- geting and financial report- sage of revised and consolidated financial regulations on procurement. ing. These budget practices lead to an input-oriented culture that focuses on “spend- 116. Governance within public expenditure manage- ing the budget” with little reward for achieving outputs or ment could be strengthened through greater transpar- outcomes. At the same time, due to chronic shortfalls in ency and accountability. There are several areas where actual revenues, budget adjustments are effectively car- more openness about the use of public money would be ried out through cash rationing by the Treasury vis-à-vis welcome, including: budget execution reports with greater ministries and other agencies. This leads to ad hoc prioriti- frequency than the present bi-annual reports; information zation of non-discretionary expenditures, such as salaries, about contract awards and associated terms; information to the detriment of other priority items. While Sri Lanka’s about resources availability to individual primary service government has nonetheless functioned relatively well units (e.g. schools); and presentation of audit findings. under these circumstances, sector performance suffers as Providing for greater public awareness and understand- a consequence. ing of the public sector’s use of resources would enhance accountability. Efforts towards this objective could include 114. Public investment planning is further impacted making budgeting and financial information more easily by capacity and procedural issues. Capacity could be understood by non-financial specialists as well as provid- strengthened to raise the effectiveness and efficiency of ing public access to proceedings of parliamentary com- public investments. A key issue is the limited capacity to mittees on public accounts and public enterprises. assess the planned effectiveness of investments in order to prioritize among various needs. Efficiency depends on the quality of planning and life-cycle costing prepared by respective sector ministries or departments. The Depart- ment of National Planning must approve the investments, but it lacks engineers, quantity surveyors or other tech- 33  In some cases forgoing competition was due to conditions of ex- nical specialists to check assumptions and estimates. Re- ternal financing for projects. There have been allegations of inflated cost current cost requirements linked to investments are rarely to the government. See, for instance, Kumarage, Amal, “Road Building or factored into the assessment. Rip-Off?” Sunday Times, December 21, 2014. 52 | III. Addressing the Fiscal Challenge G. Medium-Term Fiscal Sustainability selected niches of the society; and reduction of fuel excise taxes for 2015 and beyond. The related costs were expect- 117. Fiscal sustainability analysis suggests high risks ed to be financed by one-time taxes36 and lower public in- to slower than projected growth, higher primary defi- vestment. However it is yet unclear whether the narrowed cits, or higher borrowing costs. Public debt, hovering deficit target of around 5 percent of GDP set for 2015 can around 106 percent of GDP in 2002, was reduced to 75.5 be achieved. Over the medium term, the government percent of GDP by 2014 -- reflecting relatively low bor- plans to massively increase expenditures on education rowing costs and strong growth, supported by gradually and health from their present low levels. Since revenue will improving primary balance. However, fiscal sustainability drop in 2016 once the one-time measures expire, reduc- analysis carried out in 2014 highlighted some important ing public debt to maintain fiscal sustainability and hon- risks. First, slower-than-projected growth (alone or com- or medium-term commitments will require increasing tax bined with a higher primary deficit and higher borrow- revenue collection through permanent measures sooner ing costs) could stop or reverse the decline in debt ratio.34 rather than later. Moreover, the relatively high share of foreign currency-de- nominated debt (at 42 percent of the total as of 2014) also creates a vulnerability to currency depreciation. Sri Lanka’s H. Priorities in Addressing the Fiscal public debt was 614 percent of total government revenue Challenge and grants at end 2014, highlighting the fact that a moder- ate increase in borrowing costs could eat up a large share 120. Continued strong commitment to fiscal sustain- of revenues. ability will require long-term domestic revenue mobi- lization efforts. Honoring medium-term commitments 118. A slowdown in growth or adverse shock may re- while reducing the fiscal deficit and public debt will re- verse the downward trend in public debt to GDP. The quire increasing tax revenue collection through perma- reduction in the public debt-to-GDP ratio has been largely nent measures beyond 2015. due to fast GDP growth and low average real interest rates on debt in the backdrop of a relatively stable currency. If 121. Simplify the tax regime and improving tax ad- growth slows, a sudden fiscal adjustment might be need- ministration. Sri Lanka has extremely low and declining ed to contain the debt level. The low level of fiscal reve- revenues driven by a complex tax regime and poor tax nue, the still high level of public debt and persistent fiscal administration. Low revenues and rigidity in expenditures deficits leave little room for counter-cyclical fiscal policy. is causing the country to undercut investment in human Government guarantees given to state-owned and private development just when its transition to a MIC poses new establishments have risen fast from 1.6 percent to 5.7 per- challenges. cent of GDP between 2006 and 2014, and could pose a risk to the fiscal position. 122. Improve the adequacy and effectiveness of spending. Low levels of public spending on health, ed- 119. The fiscal deficit could expand in 2015, requiring ucation and social protection undercut Sri Lanka’s past long-term revenue measures to ensure sustainabili- strong gains in human development and leave it less well ty going forward. The new government presented its equipped to face changing human development needs budget for 2015 to the Parliament in January 2015. An as a MIC. Sri Lanka will also need to finance infrastructure extension to the budget presented by the previous gov- needs to keep pace with urbanization, the need for cost-ef- ernment for 2015 in October 2014,35 it includes the fis- fective power, and other infrastructure. Beyond increasing cal costs pertaining to the promises made by the losing fiscal space for these priority projects, there is need to im- candidate who was then in power as well as those of the prove efficiency of spending, towards improved targeting winning candidate. The result has been a change in the of benefits, including those recently approved in 2015. composition of expenditures toward recurrent spending due to: increases in public-servant salaries; new and ex- panded subsidies, including a reduction of prices of fuel and essential goods through lower taxes and benefits to 36  The most significant being a super gains tax (a 25 percent retroactive tax imposed on individuals or corporates who generated profits over LKR 2.0 Billion in 2013/14). In addition the measures include collection of tax arrears (by offering credit to those who have left tax payments in arrears at concessional interest rates from the banking sector) and levies/taxes 34  IMF Article IV Assesment for July 2014. on selected entities such as the Sri Lanka Tea Board and Telecom Regula- 35  A month before announcing the snap presidential election tory Commission. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 53 123. Improve the efficiency of spending on social on social protection has a maximum impact in reducing protection and public-sector personnel management poverty. Similarly, improving controls on public-sector re- that undermine the effectiveness of the state. Reduc- muneration and reducing political influence in civil service ing fragmentation and improving targeting of the existing management could substantially improve the efficiency of social protection system can ensure that every dollar spent public service delivery. KEY KNOWLEDGE GAPS ■■ Fiscal sustainability analysis to incorporate recent policy changes and to reflect medium-term plans. ■■ Tax expenditure analysis of fiscal incentives. ■■ Functional review of tax administration to identify collection vulnerabilities. ■■ Distributional analysis of alternative tax reforms options. ■■ Effectiveness of spending on infrastructure in terms of rate of return and impact on access and reduction of poverty. 54 | III. Addressing the Fiscal Challenge IV. FOSTERING GROWTH AND JOBS FOR THE BOTTOM 40 PERCENT Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 55 KEY PRIORITIES ■■ Review and revise the country’s trade-related policies. ■■ Invest in education and training and enhance the dialogue between private sector and education system to ensure that the population has the skills demanded by high-productivity enterprises. ■■ Promote innovation by establishing linkages between R&D institutions and networks of entrepreneurs that can benefit. ■■ Improve the regulatory environment to allow firms to grow, reducing informality and allowing for econo- my-wide increases in productivity as firms can reach economies of scale. ■■ Review the role and participation of the public sector in the economy. A. Ample Opportunities for Success 126. It is also located along a major trade route, open- ing opportunities to serve as a regional trading hub. 124. Sri Lanka has a number of advantages that pro- Less than 20 kilometers off its shores is the main East-West vide ample opportunities for further development. Indian Ocean shipping line, connecting East Asia to West Notwithstanding ongoing challenges, the country boasts Asia, Africa, and Europe. New investments in the country’s overall strong human capital and a reliable infrastructure port infrastructure – the new Colombo (South) Port exten- base, particularly when compared to other South Asian sion and the Hambantota Port – have enhanced capacity countries. It has ended its internal armed conflict with for handling ship-based trade. The former has increased Sri signs of an emerging long-lasting settlement to address Lanka’s container handling capacity by 50 percent, mak- grievances that fed the conflict. Although it is still too early ing Colombo the 27th busiest port in the world, handling to judge their impact, governance reforms initiated should about one-third as many containers as Dubai and one- bring about more accountability and hence more respon- sixth as many containers as Singapore in 2013 (Container- sive and effective government. Coupled with a demon- ization International Yearbook 2013). The latter has made strably democratic system, this should strengthen further Sri Lanka an important transshipment hub for the Indian public confidence in government and hence stability. car market, with around 15,000 vehicles being handled each month. The Hambantota Port is being geared as an 125. Sri Lanka enjoys an enviable location in a industrial port (unlike the transshipment-only port at Co- fast-growing region. Proximity to growing regional econ- lombo). Meanwhile, Sri Lanka’s Katunayake airport contin- omies – at its closest point Sri Lanka is only 26 kilometers ues to be a key passenger and cargo-handling destination across the Palk Strait from India – provides major opportu- in South Asia and the national airline is a leading carrier nities. Sri Lanka currently has bilateral trade agreements of passengers into the Indian sub-continent. The success with both India (ISFTA) and Pakistan (PSFTA), the two larg- of the new airport at Mattala remains in doubt, but the est economies in South Asia. It also has two regional trade facility affords an opportunity for investments in cargo/ agreements – one with the South Asian region (SAFTA) air-freight handling and aircraft Maintenance Repair and and the other with wider Asia (APTA), and a trade in goods Overhaul services. The close proximity of the airport to the agreement in negotiation with China. Proximity to India, seaport, together with the nearby industrial park, could with its estimated 250 million middle-class consumer pop- make Hambantota a successful trading hub for South Asia ulation by 2016 – over 20 times Sri Lanka’s own domestic (similar to Penang Export Hub in Malaysia), with the right market – offer a large export market for Sri Lankan produc- investment promotion strategies. ers. Already in the first 14 years of the ISFTA, exports to In- dia have grown by 1,000 percent, and the number of prod- 127. Sri Lanka’s boasts unique natural assets, with a temperate climate, diverse topography, and rich biodi- uct lines exported to India has grown fivefold (increasingly versity. Sri Lanka has a fertile land providing for agricul- in higher value products). India has become Sri Lanka’s ture, plentiful water resources and extensive stocks of fish third largest export market, behind the United Kingdom in its maritime waters. Its topographical variation and lo- and the United States. There are also extensive opportuni- cation as an island near the Asian mainland has led to rich ties for developing trade in electricity with India. biodiversity, making it one of the world’s 35 biodiversity ‘hotspots’ (Conservation International). It boasts UNESCO’s 56 | IV. Fostering Growth and Jobs for the Bottom 40 Percent natural World Heritage Sites and offers the unique Figure 4.1 Annual tourist arrivals, 1967-2013 opportunity to see in one day the ‘Big Four’ mam- mals – leopard, bear, elephant, and whale. There is considerable potential for the development of na- 1800 ture-based tourism. It has a high rate of endemism Tourist arrivals (thousands) of flora and fauna and great genetic diversity of ag- 1600 ricultural crops, with 3,000 varieties of rice having 1400 been recorded as well as a large variety of coarse grains, legumes, vegetables, spice crops, roots and 1200 tubers. It is renowned for its tea, coconut, and cin- 1000 namon. The country has significant potential for the export of high-value agricultural products. 800 128. Natural assets together with cultural and 600 historical assets provide a strong basis for tour- 400 ism, which is only beginning to grow since the end of the war. There has been a marked rise in ar- 200 rivals since 2010, but there is potential for a much 0 bigger increase (Figure 4.1). Sri Lanka has recently 1970 1973 1976 1979 1982 1985 1988 1991 1994 2000 2003 2006 2009 2012 1997 been recognized as one of the Top 10 global tourist destinations by National Geographic (2011), Lonely Planet (2012) and the New York Times (2013). The Source: Sri Lanka Tourism Development Authority. * Provisional. country’s tourism assets are relatively well known and the island has a broad appeal since it offers beach and in Colombo. Although some new attractions different experiences found in other destinations in the have been developed in the North -- such as the Ridiyag- South and Southeast Asia region (e.g. the Maldives, India, ama Safari Park, the Pinnawela Open Zoo, the Wet Zone Thailand, Malaysia, Indonesia, and Vietnam). Sri Lanka has Botanical Garden, and a number of new national parks -- the advantage that all these experiences are available on there is scope to develop tourism in the East, North and an island roughly the size of Ireland or Costa Rica. Howev- Northwest of the island (Box 4.1). er, tourism investments in Sri Lanka have been targeting a small part of the island, with 98 percent of tourist beds 129. Globally competitive companies have emerged concentrated in the South and West of the island along the in Sri Lanka, particularly in the apparel and IT sectors. Box 4.1 Tourism on the rise but constrained by capacity The sector that picked up the fastest following the end of the war was tourism, with the country receiving global acclaim as a leading tourist nation. The unique product offering owing to the diverse attractions in a compact area gives Sri Lanka an edge over many other Asian destinations. New tourist hotels have been one of the most robust sectors for increased private investment after the conflict ended. Global chains like Shangri-La Group (Hong Kong SAR, China/Singapore), India’s upscale ITC Group, Thailand’s Minor Group and Banyan Tree, Spain’s RIU Hotels & Resorts, Singapore’s Aman Resorts and Mustafa Group have begun investing in the country. In addition, international brands such as Sheraton, Marriott, Hyatt, Movenpick and Onyx have signed management agreements with local hotel companies. Locally, several of the domestic conglomerates, including Jetwing, John Keells, Aitken Spence, Hemas, Citrus and Dilmah have expanded their tourism investments. These new additions and upgrades are increasing both the supply and quality of medium- and high-end accommodation that is needed for continued growth. However, the growth of the sector could be severely hampered by inadequate capacity. It is projected that an additional 30,000 new rooms are required across Sri Lanka to cope with growing demand. The tourism industry would need to invest in different segments of new accommodation to meet different tourist needs – from city hotels, large resorts, high-end boutique hotels and villas, as well as tented camps and rural bungalows. Alongside this, 50,000-60,000 new hospitality staff needs to be trained to support just the growth in room inventory. Sri Lanka currently has the capacity to train only around 1,800 new graduates each year. At the same time, the tourism sector requires professionals in other disciplines, such as marketing, IT and sports/recreational training. Additionally, Sri Lanka would need to develop new destinations across the country (particularly in under-developed locations with natural assets in the North and East), and diversify the product offering in order to cater to a wider variety of tourist needs, while remaining conscious of the environmental and social pressures brought on by rising tourist numbers. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 57 Although initially facilitated by government Figure 4.2 Balancing between inward vs. outward orientation and public vs. liberalization policies in the late 1970s and private sector driven development; Sri Lanka 1965-2013 the 1990s, respectively, these companies have proven resilient to changing conditions. The apparel industry has moved from a commod- 95% (Private as percent of total Fixed Capital Formation) ity exports model to successfully targeting 90% 2000 niche markets for higher-value added produc- Public Sector Led <---------------> Private Sector 85% Driver of Economic Development tion. The IT sector has also grown, with Sri Lan- 2013 80% 1980 ka most recently ranked 16th as a destination 75% for locating Business and Knowledge Process 1970 Led Outsourcing services in the Global Services 70% Location Index in 2014,37 moving up from 65% 29th in 2007. Several Sri Lankan IT companies 60% have attained global recognition in providing 55% software solutions for stock exchanges, mo- 50% bile and internet payments/banking, human 40% 50% 60% 70% 80% 90% 100% resources management, supply chain and re- Inward <--------------------------------------------------> Outward tail management, simulation games for the Orientation of the Economy defense industry, and technology product (Exports + imports as a percent of GDP) design (software and hardware integrated en- gineering). Source: World Development Indicators. All data refer to Sri Lanka 130. For Sri Lanka to capitalize on its lo- cation, human and physical assets, and demonstrated that Sri Lanka is less competitive on measures that capacity to develop globally competitive firms, it will reflect openness and the quality of government inter- need to find an effective balance along two axes: (i) in- vention. The GCI points to particular weaknesses in terms ward vs. outward orientation of the economy; and (ii) of property rights, favoritism in government policy, and la- the respective roles of the public and private sectors. bor legislation. The Index’s scores for most indicators (and The story of Sri Lanka’s economic development over the all indicators in the Figure 4.3) are based on assessments past 30 years has been dominated by the country’s move- of business executives familiar with Sri Lanka and, as such, ment along these two dimensions (Figure 4.2). In the past provide an independent qualitative assessment of the decade, policies have moved the country towards a more strengths and weaknesses of the business environment.38 inward-looking, public sector-dominated model. This mod- el of growth led by domestic B. Inward versus Outward consumption, and to a lesser Sri Lanka needs an extent public spending, has Orientation of Economic Activity effective balance of made it an outlier compared 132. Sri Lanka is smaller and less open today than it inwards vs outward to other fast-growing coun- tries in Asia, which are more was for most of the last 30 years. Before 1977, Sri Lan- orientation and export oriented. Given the ka’s development strategy, based on import substitution, between the public fiscal pressures discussed aimed to create a comprehensive welfare state. Post-1977, reforms aimed to liberalize the foreign trade regime and in Chapter III, it will be dif- and private sectors ficult to sustain high levels Sri Lanka was seen as the first country in South Asia to of growth by relying on the significantly open its borders to trade and foreign direct public sector alone. While there is no “right” location on investment. In the decades that followed, trade of goods either axis, Sri Lanka’s progress going forward will likely and services increased to 89 percent of GDP in 2000, with involve recalibrating its economic orientation and the role tea and high-end apparel exports leading the way. After of the public sector. the beginning of the new millennium, however, trade steadily declined to 54 percent of GDP in 2013. FDI remains 131. The Global Competitive Index (GCI) suggests at below 2 percent of GDP five years after the end of armed 37  GSLI is released by A.T. Kearney, a technology consultancy. 38  In the case of Sri Lanka there were 100 respondents to the survey. 58 | IV. Fostering Growth and Jobs for the Bottom 40 Percent Figure 4.3 Obstacles to global competitiveness, rankings conflict. The decline in openness and stagnating FDI took place when the rest of the world was integrating Favoritism in more strongly and global trade was decisions of govt University- officials accelerating. Sri Lanka’s world market Burden of industry 140 government share has consequently declined to collaboration in 120 regulation levels last seen in the 1980s. Technological 100 Ethical behavior readiness 80 of firms 133. Overall export performance is mainly in unsophisticated prod- 60 Financial market uct lines, notwithstanding the 40 government debt, development success of some niche companies. 20 Sri Lanka’s exports of manufactured 0 goods per capita are only one-third Women in labor Health and and less than half of China’s or Viet- force, ratio to men primary education nam’s levels, respectively (Figure 4.4A). Not much more than one-tenth Country capacity Tertiary education of the exports are for skill- and cap- to attract talent enrollment ital-intensive production with the Hiring and firing Total tax rate, % rest being low-added value skills and practices profits resource intensive products (Figure Trade tariffs, % duty 4.4B). IT exports tripled between 2007 and 2014, but still make up less than 4 percent of total exports. Sri Lanka’s India Sri Lanka export performance highlights the Korea, Rep. Thailand huge untapped potential in the trad- Malaysia able sector. It also implies that there are significant barriers holding back Source:World Economic Forum, 2014-15 private creativity to realize the eco- Figure 4.4 Exports per capita are low and Labor-intensive A. Exports per capita (US$) in 2012 B. Skill & Capital intensive exports (percent exports) 2000 70% 60% 50% 40% 30% 20% 10% 0 0% CHN VTN BTN LKA IND BGD PAK MDV NPL BTN CHN IND NPL PAK VTN MDV LKA BGD Capital Intensive Manufacturing (CIM) Resource Based Manufacturing (RBM) Skill Intensive Manufacturing (SIM) Labor Intensive Manufacturing (LIM) Source: World Bank Poverty Assessment 2015 Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 59 Figure 4.5 Sri Lanka’s exports by product category in 1990 vs 2013 Vegetable Stone and Glass Miscellaneous Metals Textiles and Clothing 32.52% 9.84% 4.64% 1.65% 34.76% Fuels Animal 1.46% 1.35% Plastic or Rubber Wood Hides Mach 6.19% 0.82% and and Elec 1.23% Skins Minerals Food Footwear Textiles and Clothing Vegetable Stone and Glass Food Mach and 46.23% 21.26% 9.84% Products Elec 3.13% 3.13% Animal Wood Metals 2.51% 1.52% Plastic or Rubber Transportation 10.14% 1.45% Miscellaneous 1.62% Chemicals 1.42% Source: World Integrated Trade Solution. nomic potential of Sri Lanka’s relatively educated labor dustrial parks with preferential tax treatment and specific force. Additionally, the export product categories have regulatory conditions aimed at attracting manufacturing remained largely the same over two decades (Figure 4.5). FDI. Originally adopted as a policy objective in 1978, EPZs took on greater prominence during the second phase of 134. What explains the inward orientation and lack of reform in the 1990s, with the establishment of the BOI, and diversification? This section aims to unpack the reasons continued to be used as a strategy to encourage FDI and for the relatively slow growth in exports and lack of dyna- boost manufacturing exports. The government extended mism in the emergence of new economic sectors. In addi- incentives to industry to set up in EPZs, provided special tion to trade and industrial policies and regulatory hurdles, customs facilitation, duty-free imports of intermediate in- the focus will be on the barriers to attracting FDI, the avail- puts and equipment, tax exemptions and preferential tax ability of skills for a competitive economy, and innovation rates, streamlined administration, and subsidized utilities. policies that promote diversification. A parallel policy objective during this time was the indus- trialization of rural communities (targeting employment Trade and Industrial Policies for rural youth) and the expansion of the apparel industry through the implementation of the 200 Garment Factories 135. Sri Lanka’s export production basket is still a Program. This was aimed at both domestic and foreign reflection of the outward-oriented economic policies investors, inside and outside the EPZs. Much of the early adopted in the years following the two waves of lib- investment into the EPZs was by foreign firms and con- eralization – first in 1977-79 and then in 1990-92. The centrated in the garments sector, taking advantage of the government created Export Processing Zones (EPZs) – in- Multi Fiber Agreement quota for garment exports to EU 60 | IV. Fostering Growth and Jobs for the Bottom 40 Percent Figure 4.6 Nominal trade protection, 1982–january 2011 (percent) 137. There has been an increase in para-tar- iffs in the past decade. This has not only signifi- 45 cantly increased nominal protection and prices of imports, but has also added to trade policy 40 complexity. The combined system of the Most Fa- 35 vored Nation applied tariff rate and the para-tariffs 30 has made the present import regime one of the 25 most complex and protectionist in the world.40 Im- plementing para-tariffs has effectively doubled the 20 protection rates to 24 percent (Figure 4.6). Worse 15 still is the para-tariffs’ dispersion, which leads to 10 prices that distort production and consumption patterns. Last, higher rates of protection on final 5 products than on inputs used in their production 0 lead to high effective protection rates and anti-ex- 1982 1997 Nov-02 Jan-04 2009 Jan-11 port bias, because producers have strong incen- Average total nominal protection rate Average para-tariff rate tive to sell goods domestically even though their Average MFN tariff rate domestic costs are higher than their opportunity costs through trade. This is particularly worrying in Source: Kaminski and Ng 2012. the case of the agricultural sector, given that a large share of the bottom 40 percent of the population markets. This then explains part of the structural transfor- continues to be agricultural producers. Trade barriers also mation described in Chapter II: whereas foreign export-ori- make it more difficult for local producers to access inputs, ented manufacturing firms accounted for only 24 percent reducing their competitiveness and ability to integrate in of the total in 1977, they accounted for around 80 percent global value chains. Firms are also less likely to invest in of all manufacturing exports in the 1990s. Firms with an capital equipment that would raise productivity and pro- agreement with the BOI accounted for half of manufactur- mote technology transfers. ing exports by the 1990s. The establishment of manufac- turing export firms attracted international buying groups 138. Stagnating product diversification and weak ex- with links to these foreign firms, establishing local offices port performance has come on the back of an industri- in Sri Lanka. al policy orientation in the past decade that does not promote competition and aims to protect domestic in- 136. While Sri Lanka’s industrial policy has been dustry. Although successive governments after 1977 car- broadly market-oriented ried out ad hoc import substitution policies, these did not since liberalization in the have a significant aggregate impact on trade policy. The There has been 1970s, the degree of outward decade since 2005 has seen the most extensive measures were adopted, where the focus noticeably tilted towards a noticeable orientation has wavered. The two rounds of economic liber- promotion of domestic agriculture (with generous sub- slide towards alization introduced a series of sidies and guaranteed prices), domestic industries (with protectionism in the reforms towards deregulating specific tax breaks and tariff protection), and wide-scale public infrastructure programs (particularly connective in- last decade the economy, accompanied by a strong focus on export orien- frastructure like highways and ports). tation and FDI promotion. These reform rounds were ac- 139. The government has been interventionist, “tilt- companied by incentives to promote exports, including a ing the playing field” in many areas through a web of favorable special tax regime and favorable operating envi- tax and trade policy incentives for a large number of ronments with easier customs facilitation and import duty domestic sectors and actors. As noted in Chapter II, there cuts. But in the last decade (since the mid-2000s), there are now over 500 VAT exemptions for various industries has been a noticeable slide towards protectionism and in- and actors and 48 various types of income-tax holidays, dustrial policy has focused more on promoting domestic many of which are quite expansive (such as “new under- enterprises.39 takings in less developed areas”). Many of the incentives appear to benefit a specific, small set of firms. For instance, 39  Kaminski B and Ng F (2013) ‘Increase in Protectionism and its Impact on Sri Lanka’s Performance in Global Markets’, World Bank, p3. 40  Pursell 2011a,b Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 61 in 2012, the government announced fiscal measures to Sri Lanka’s agriculture production structure has remained support import substitution industries in cement, pharma- concentrated in the basic and relatively low-value food ceuticals, steel, fabric and milk powder. Without any wide crop. In 2013, about 66 percent of the cultivated area was scale existing local entrepreneurship in these sectors to under rice cultivation but the share of rice in the overall take advantage of these concessions, it was apparent that value of crop production was only about 20 percent. De- such measures were targeted to benefit a handful of firms. spite growing domestic demand and potential for export growth, higher-valued crops, in particular fruits and veg- 140. FDI has also been promoted through incentives etables have not expanded, while growing demand has for specific investors provided through BOI and under been met by increased imports of, for example, dairy prod- the Strategic Development Projects (SDP) Act, giving ucts, potatoes, onions and maize. government a large, direct role. The SDP Act in particu- lar provides fast-track approvals, exemptions from a range 143. A recent EU ban on Sri Lankan fish exports fur- of income and border taxes, and special treatment on ther limits export potential in a sector that is import- land ownership. The act allows for negotiation of individ- ant for the bottom 40 percent. In February 2015, the EU ual deals and the eligibility of projects are discretionary; imposed a ban on fish imports from Sri Lanka over con- whether a project is strategic in nature can be left to inter- cerns on Illegal, Unreported, Unregulated fishing. The EU pretation by the subject minister, so long as it is in a sector is the main destination of fish exports of Sri Lanka, with that is specified in the act. Many of the 13 SDPs that have about 42 percent of fish exports being shipped to the EU been approved have been unsolicited proposals. There is in 2013. The fisheries sector employs an estimated one mil- little reporting on their terms, particularly tax benefits and lion citizens, contributing over 1.8 percent of GDP in 2014. the terms for use of land, nor is it possible to determine fis- Much of the population involved in this sector is located in cal impacts by available budget data. The upshot of these the Northern and Eastern Provinces. Recent analysis using regimes is that prospective investors have a strong incen- a Computable General Equilibrium model found that the tive to negotiate with government to secure privileges. overall effect of the ban on Sri Lankan fish could cause a This is particularly the case with SDPs where terms are de- decline in Sri Lanka’s GDP growth rate by 0.01 percentage points and a 3 percent increase in poverty from 6.74 to cided on a case-by-case basis; BOI incentives are uniform 6.94 percent.41 Although the ban is on the fishing sector, for all investors. unskilled workers in agriculture and other sectors are like- 141. The government has also made attempts to en- ly to be the most adversely affected due to inter-sectoral courage greater domestic value-addition of manufac- linkages and because of increased competition with work- tured exports as well as commodity exports. This was ers who lose their fishing jobs. done by introducing high taxes (called ‘cesses’) on exports 144. Sri Lanka’s new policy makers will need to re- in “raw form” as determined by the government. The taxes view and revise the country’s trade-related policies in are primarily imposed on exports of tea, rubber, cinnamon, order to promote economic diversification and shared coconut and spices. Revenues from cesses are supposed growth. The links between growth performance and spe- to be then invested in R&D for the corresponding sectors cific trade policies are ambiguous and depend on many again to encourage value addition. It is yet to be seen endogenous and exogenous factors such as factor endow- whether this has had any significant impact on boosting ments, geographical location, demography, etc. Each pol- value-added exports of primary commodities. These pol- icy comes with its own set of challenges. For example, im- icy measures would need to be accompanied by steps to port substitution laid the foundation for industrialization increase competitiveness and innovation of firms in these in Brazil but at some point led the economy to collapse sectors to truly be able to move up the value chain. The under the weight of accumulated inefficiencies. Some falling prices of key commodities – like natural rubber (due East Asian countries (e.g. Japan, South Korea) caught up to the global expansion of synthetic rubber) – have also with developed economies while keeping multinational hurt the ability of traditional firms to finance industrial up- corporations and FDI largely out of the country whereas grading in line with government policy directions. others (e.g. Malaysia, Singapore, Thailand) actively sought to attract foreign investors and benefited from positive 142. Inward orientation and lack of diversification are spillovers. In the case of Sri Lanka, moving from growth fu- reflected in the structural characteristics of Sri Lanka’s eled by reconstruction and infrastructure towards growth agriculture sector. Although, agriculture has contributed based on a diversified and competitive economy will likely about one-third to Sri Lanka’s poverty reduction over the require a rethinking of the policies in place and their suit- past decade (Chapter II), the sector has remained in a low productivity equilibrium including the plantation (tea, co- conut, rubber) and field crops sectors. Achieving self-suffi- ciency in rice has been a success but has also meant that 41  Sahin et al, 2015. 62 | IV. Fostering Growth and Jobs for the Bottom 40 Percent Figure 4.7 Net Inflows and composition of FDI A. Composition of aggregate demand B. Composition of FDI (percent of GDP) 1,600 Hong Kong SAR, China Singapore 1,400 Mongolia 1,200 Maldives infra- 1,000 structure Cambodia US$ mn Vietnam 800 Lao PDR 600 services China 400 Malaysia manu- Thailand 200 facting Bhutan 0 Indonesia 2009 2010 2011 2012 2013 India Port Container Terminals Sri Lanka Power Generation, Fuel, Gas, Petroleum and Other Philippines Telephone and Telecommunication Network Bangladesh Housing, Property Development and Shop Office Korea, Rep Other Services Pakistan IT and BPO Nepal Hotels and Restaurants Afghanistan Manufacturing 5.00 10.0015.0020.0025.0030.00 Agriculture Source: World Bank World Development Indicators ability as foundations for the economy of the future. 146. Not all FDI has the same potential for positive spillovers to the economy. FDI inflows to Sri Lanka have Attracting and Retaining Efficiency-Enhancing been largely focused on infrastructure (inclusive of real Foreign Direct Investment (FDI) estate development), with a relatively small proportion reaching sectors of the economy that are associated with 145. FDI is needed as a foundation for economic di- global networks of production (Figure 4.7B). There are versification, but Sri Lanka’s performance has been broadly three types of FDI: (i) natural-resource-seeking; (ii) disappointing. In addition to boosting investment neces- market-seeking; and (iii) efficiency-seeking. When consid- sary for growth and providing long-term balance of pay- ering investment policy, it is critical to acknowledge that ments financing, FDI can help enhance the sophistication the factors that motivate, dissuade and impact investors of Sri Lankan products and exports through introduction are vastly different depending on the business they are of new technologies and production processes. It can also in, and the markets they target. The basic motivations of give rise to positive spill- an investor provide an insight into the socio-econom- Levels of FDI have overs through improvement ic impacts that the firm may have in Sri Lanka. Countries of skills and introduction of been disappointing new management practic- often make the mistake of designing investment policies around the type of foreign investments that they already es. Finally, FDI can enhance access of Sri Lankan producers to global production net- have, rather than tailoring policies to suit the type of in- works and facilitate the development of new activities vestment that they want to grow. In that regard, it is im- within existing value chains (increasing value added in portant for authorities to identify those types ofinvestors production). However, FDI in Sri Lanka has been lower that are more likely to make a positive contribution to the than in peer countries in spite of Sri Lanka’s comparative domestic economy. In turn, this identification should be advantages, such as its location and access to major mar- consistent with the investment policy that is developed kets (Figure 4.7). for the country. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 63 Box 4.2 Global experience in attracting and retaining FDI: infrastructure and incentives are not major factors The Multilateral Investment Guarantee Agency conducted a Global Investment and Political Risk survey of investors in 2013 to identify the main factors that inform the selection of investment destinations. Global investors seek macroeconomic and political stability in the host country as a foundation. Beyond that, the availability of qualified staff is the most important decision element, and one that has grown rapidly in relevance over the past few years. Other factors, such as the availability of infrastructure, have substantially decreased in importance when investors select locations. Notably, while the size of the domestic market used to be a major decision factor, it has become less important owing to shifting interest towards efficiency and linkages to global markets. The views of global investors offer insights that can be used to determine the priorities for policies and investments aimed at attracting and retaining FDI. They also highlight the fact that bringing FDI to Sri Lanka will require much more than investment in infrastructure and incentives to investors. Research on other countries has demonstrated that: (i) incentives alone can be insufficient to attract efficiency-enhancing FDI; (ii) retention of FDI is low as incentives pose a significant fiscal strain and investors often switch investment destinations when incentives dry up; and (iii) fixing enabling-environment deficiencies can be more effective than offering incentives to cover for such deficiencies. Sri Lanka may consider other factors to attract investment, including: • Minimizing uncertainty and fostering investor confidence through certainty on policies and regulations. • Eliminating unnecessary regulatory and policy obstacles to FDI. • Investing in education to ensure that the population (and especially the youth) has the skills demanded by efficiency-enhancing enterprises (see below). • Establishing a level playing field that fosters competition and eliminates preferential treatment for specific public or private players. • Developing a well-functioning financial sector that can actively contribute to the development of local firms that can be part of the ecosystem around foreign enterprises. Minimizing uncertainty and fostering investor confidence. Governments have a major role in building investor confidence through ensuring predictability and consistency in regulations that govern the activities of foreign investors, as well as protecting investor rights and ownership. Arguably, this confidence is particularly important in attracting efficiency-seeking investors, whose business model depend on productivity and reliability of production (which can be easily disrupted by regulatory changes), rather than on cheap access to natural resources. Recent actions including the appropriation of 37 “underutilized” assets, as well as the proposed/upcoming changes to land laws, significantly undermine the confidence of foreign investors on Sri Lanka, and reduce its competitiveness as a long-term investment Factors that inform the selection of investment destinations A. Main obstacles to FDI B. Top political risks from 2012-2015 Macroeconomic Adverse regulatory instability changes Political risk Breach of contract Transfer/convertibility Lack of qualified staff Deficiencies in financial Civil disturbance sector in host countries Non-honoring of gov't Weak government institutions/red tape/ Expropriation/ nationalization Poor infrastructure Terrorism Limited size of the market War 0% 5% 10% 15% 20% 25% 0 10 20 30 40 50 60 70 2013 2010 Source: MIGA (2013) World Investment and Political Risk Report, IBRD/World Bank. 64 | IV. Fostering Growth and Jobs for the Bottom 40 Percent destination in favor of jurisdictions that can provide a higher degree of certainty to foreign investors. Investment entry barriers include both (de jure) rule-based, legal barriers and (de facto) factual barriers that arise on the ground. Although most countries in the world seek to attract foreign investment, very few countries maintain an entirely open investment regime. Some limitations may intentionally discriminate against foreign firms, such as when a country closes a sector for security or cultural reasons, or protects a domestic industry. Other limitations may arise as a substitute for regulation, or because of institutional dynamics and inefficiencies. In addition to policy obstacles, there are procedural barriers, including documentation requirements, as well as de facto barriers such as lack of enforcement or excessive discretion on the part of public officials. Research conducted on OECD countries, estimated FDI increases after the removal of specific restrictions (Table B1). While these figures may not necessarily reflect the situation in Sri Lanka, they highlight the potential of reforms in enhancing the attractiveness of a country as an investment destination. In the case of Sri Lanka, the World Bank has not undertaken a formal assessment of specific barriers. Such analysis would help in order to identify the current obstacles that may be further reducing the attractiveness of the country as an investment destination. Table B1 FDI Flows: the hypothetical effect of removing FDI restrictions Type of FDI restriction removed Percent change in inward FDI Removal of foreign equity ceilings 77.9 Removal of approval and national interest tests 21.2 Easing of nationality requirements on management 10.1 Source: OECD Research (2003) 147. Using incentives may not be an effective tool to transformative potential, it should analyze the effective- attract efficiency-enhancing FDI to Sri Lanka. Invest- ness and adequacy of incentives together with the costs ment incentives can be used to compete for potential involved in fiscal losses and potential disruption of market investors; to encourage certain business practices; and to dynamics (through, inter alia, the creation of an unleveled attract investment into priority regions and priority sec- playing field). tors. However, evidence from both survey and economet- ric studies indicate that the key determinants affecting an Ensuring Human Capital and Skills for investor’s decision on where to locate are often based on Competitiveness broad economic and investment climate factors such as market size, regulatory policies, natural resource endow- 148. The challenges of competing in the global econ- ments, infrastructure, and human capital availability (Box omy require not only high human capital and advanced 4.2).42 Investment incentives, therefore, tend to be most skills but also a workforce that can adjust to shifts in relevant at the margins of investor decision-making; they domestic and global demand. Education and training are likely to be most influential when investors are waver- are fundamental for a competitive economy, especially for ing between similar options, and when a country already the production of high-value-added goods and services.43 has a favorable investment climate. As Sri Lanka seeks to International evidence shows that skills are key to improv- enhance the attraction and retention of FDI with positive ing the welfare of individuals and ensuring that the private sector can innovate and adjust to greater global competi- tion, master processes that will increase productivity, and attract and retain FDI. 42  While many countries have sought to attract FDI through offering incentives to investors, research has demonstrated that a) incentives alone can be insufficient to attract efficiency-enhancing FDI, b) retention 149. Educational attainment of the Sri Lankan work- of FDI is low as incentives pose a significant fiscal strain and investors of- ten switch investment destinations when incentives dry up, and c) fixing enabling environment deficiencies can be more effective than offering incentives to cover for such deficiencies. 43  Ashton and Green (1996) Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 65 Figure 4.8 Completed O-levels by age group cohorts are not only more educat- ed in general, but their educational attainment has increased over time. 60 54 2002 * For example, the proportion of indi- 2012* viduals with O-levels and A-levels is 50 43 42 11 percentage points higher for 20 37 38 36 35 40 35 33 31 to 24 year olds than for 25 to 29 year 30 32 30 30 olds, while the proportion of those 29 30 25 with degrees or more for 25 to 29 22 17 year olds are higher (5 percent) 20 compared to older age groups (4 percent for 30 to 39 year olds and 3 10 percent for 40 to 49 year-olds). 0 150. Despite the past pos- itive achievements, the quality -19 -24 -29 -39 -49 a le a le l e ta ov of general education lags that To M 15 20 25 30 40 m ab Fe of many higher middle-income and countries. Sri Lanka’s quality of 50 education, as measured by annual Source: World Bank using Labor Force Survey national assessments of learning * Excludes Northern and Eastern Provinces. outcomes and periodic interna- tionally comparable tests, lags that ing age population has improved. The proportion of of several higher middle-income countries, particularly in those who have completed O-levels has increased from 30 language and numeracy skills (Figure 4.9A).44 In particular, to 35 percent, with a higher increase for females than for if Sri Lanka aims to improve its educational outcomes it males, and higher for youth than for adults (Figure 4.8). For will likely need to increase the resources devoted to edu- example from 2002 to 2012, the number of 20 to 24 year olds with O-levels increased by 12 percentage points (42 to 54 percent) while for 25 to 29 year olds it increased by 44  Dundar et al. (2014), Aturupane et al. (2014). Country selection only 7 percentage points (from 36 to 43 percent). Younger based on data availability. Figure 4.9 Learning outcomes A. Learning Outcomes in Sri Lanka and Comparator Countries, 2010 B. Cognitive Test Scores for Students in English in Sri Lanka’s Provinces, 2012 60 50 45 44 42 42 41 38 36 40 33 32 30 20 10 0 ern wa n ral n rn l rn ba ntra ter a ter ste nt u he Uv rth am es s Ce Ce ut We Ea No W rag So rth rth No No Sa Source: National Education Research and Evaluation Center, University of Colombo, 2010. Note: TIMSS is Trends in International Mathematics and Science Study, an international assessment. 66 | IV. Fostering Growth and Jobs for the Bottom 40 Percent Figure 4.10 Increasing demand for workers with better skills A. Expected additional hiring by occupation and sector (percent), B. Employers’ ranking of skills when making decisions 2013-14 about retaining white-collar workers Manufacturing 25 Tourism Job-specific technical skills Other Services Literacy 20 English 15 Leadership skills 10 Numeracy Ability to work 5 Problem-solving skills 0 Communication skills -5 Team work skills ted ng ccu rs rs ns s d a ales ers Ele chin rade ch ls rs pp ians to Pro gers ke hi tio na ke Time management skills tar pera rk or fis pa sio , fo wor ic t o a tw aft try & w an n eo fes or ce Creative and critical M a yo Te rel rvi res S su Se Pla s & a en &m al gr 0 5 10 15 20 25 30 ric m Cr Cle nt ille Sk Source: Dundar H et al (2014). cation. This is especially the case in rural and estate sectors, and 38 percent said the same about retaining low-skilled and among students from the types of schools attended workers. by low-income households where educational outcomes are weaker.45 Furthermore, there is significant variation in 152. When it comes learning outcomes among provinces (Figure 4.9B). to advanced skills and Higher education human capital, Sri Lan- enrollment is low 151. Moreover, Sri Lanka has a shortage of adequate ka has very few high- vocational and technical skills in its workforce, skills ly skilled workers, and compared to other that are increasingly in demand. Although there is an there are constraints on middle income increasing demand for mid-level technicians, in particular in the services sector, and low-skilled workers in manufac- the quality and relevance of higher education and countries and has turing, only 16 percent of workers have completed tech- research. Sri Lanka lags structural defects which 46 nical and vocational education and training (TVET), and in higher education enroll- yield a small pool of only 73 percent of those have acquired few, if any, job-rel- ment compared to other evant skills (Figure 4.10). Just 16 percent of workers know middle-income countries graduates with relevant how to use a computer and 24 percent have proficiency in (Figure 4.11A). Moreover, advanced skills English. Aptitude for these skills is lowest in the rural and enrollment in tertiary low-skilled parts of the population. Many existing training education as a proportion of labor force averaged just 1 programs in the TVET sector suffer from low quality and percent since 1995, far below enrollment rates in other a lack of relevance to the skills demanded by employers. fast-growing economies in East Asia (Figure 4.11B). Overall Importantly, the links between vocational training centers enrollment in higher education for 20- to 24-years-olds in and industry are missing. In fact, 46 percent of employers Sri Lanka is about 17 percent, whereas the average higher indicate that job-specific skills are the most important education enrollment rate for middle-income countries is factor in deciding whether to retain a high-skilled worker about 30 percent. 45  UNDP, 2014 46  Dundar H et al (2014), IPS, 2014 and World Bank, 2014b Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 67 Figure 4.11 Sri Lanka has a small stock of highly skilled workers, with trends that are not encouraging A. Gross Enrollment Rate, B. Trends in higher education enrollment rates as a Tertiary (2012) percentage of labor force, 1986–2010 40 12 Sri Lanka 35 10 India Higher Education Enrollments (%) 30 Thailand 8 25 Bangladesh Nepal 20 6 China 15 4 Malaysia 10 Singapore 2 5 Pakistan 0 0 Sri South Lower Middle Upper 1995 1997 1999 2001 2003 2005 2007 2009 Lanka and West middle income middle Asia income countries income countries countries Source: UIS http://data.uis.unesco.org/# Source: Chellaraj 2012 153. The structure and composition of Sri Lanka’s Indeed, the composition of students in the conventional higher education enrollment has multiple defects.47 degree programs of the universities is still dominated by First, the largest share of enrollment, nearly 60 percent, is disciplines such as the liberal arts, management, com- in external degree programs (EDPs), where students are merce and law, with underrepresentation of scientific and enrolled in universities and sit examinations, but do not technical fields. A middle-income country, if it is to grow follow lectures or classes, and receive no academic support fast, needs a higher proportion of skilled and competent from the university. This is a low-cost option for the gov- science and technical graduates. Moreover, enrollment in ernment to expand higher education access and coverage: employment-oriented alternative higher education insti- but it is at the expense of quality. The greatest proportion tutions in the public sector is small, at only 3 percent of of unemployed graduates is drawn from these EDPs. Sec- total higher education enrollment. Finally, leadership and ond, the balance between enrollment in the public sector communications skills are some of the non-cognitive abil- and in the private sector is heavily skewed against the pri- ities of white-collar workers that are most highly prized vate sector, which has only 12 percent of enrollment. This by Sri Lankan firms. Unfortunately, many soft skills are is due to Sri Lanka’s strongly state-centered higher educa- not learned sufficiently by Sri Lankans through the formal tion system. A major constraint to expanding private-sec- education system. To compete effectively in international markets Sri Lanka’s workforce will need to attain a higher tor participation is the absence of a clear and transparent level of computer literacy, the ability to operate the latest process for private higher education institutions to register equipment, and fluency in foreign languages.49 and obtain quality and accreditation assurances. A third major constraint is the relatively low public investment 154. The result is that Sri Lanka’s firms have difficulty that has limited the expansion of the public universities, accessing the skills they need. In 2010, manufacturing especially in the sciences, technology and engineering. In companies ranked the inadequate education of the labor fact, the proportion of students enrolled in science and force as the third most important constraint on their op- engineering has actually begun to decline since 2002.48 erations, with only Bangladesh and Afghanistan having higher such ratings in South Asia (Figure 4.12). Only elec- 47  See World Bank, 2009b. 48  Chellaraj, 2012 49  Dundar et al. 2014 68 | IV. Fostering Growth and Jobs for the Bottom 40 Percent Figure 4.12 Factors that inform the selection of investment destinations A. Skills constraints as major or severe obstacle B. Labor factors that affect firm operations and growth in for firms, latest available year 2012 ( percent) 25 25 Finding workers with previous experience High employee turnover 20 17 TVET of workers 16 15 15 Labor availability Percent Taxes and EPF/ETF contributions 10 8 Total salary cost 7 General education of workers 5 Employment protection legislation Minimum wage rate 0 tan 0 10 20 30 40 50 l esh ia ka pa tan Ind kis Lan Ne lad nis Pa ng Sri ha Afg Ba Source: Dundar H et al (2014). tricity supply and tax rates were greater concerns. This is a and what potential employers value.50 While 56 percent problem that affects firms across all sectors. If these firms of employers think that high-skilled workers should pass cannot find the skills that they need, they will not be able to upgrade their processes and products to compete in a more liberalized trade regime. 50  Dundar et al (2014). Overall skills stock of the labor force is mea- 155. There is a mismatch between the level and type sured from the STEP household survey of the population 15-64 years old. of skills taught by the education and training system The employers’ view of available skills is measured from the STEP employ- er survey and serves as a proxy for the skills demand. Figure 4.13 Education and training mismatches 70 None or less 60 than primary Primary 50 40 Lower secondary 30 Passed O- 20 levels 10 Passed A- levels 0 Bachelor Total Highly Low skilled Highly Low skilled Highly Low skilled skilled workers skilled workers skilled workers Master or PhD workers workers workers Self-employed Wage employed TVET OVERALL SKILLS STOCK OF THE LABOR FORCE EMPLOYERS' VIEW OF AVAILABLE SKILLS Source: Sri Lanka STEP Household Skills Measurement and Employer Surveys. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 69 Figure 4.14 Inadequate skills lead to low returns to education A. Employers’ perception of general education, TVET, and B. The returns to education have been declining university, percent 30 Meet the skill needs adequately 25 Level of skills needed 20 Kinds of skills needed 15 Up-to-date methods, 10 materials, technology 5 Practical skills - Attitude and self-discipline 2006 2007 2008 2009 2010 2011 2012 0 20 40 60 80 Primary O-levels General education University TVET A-levels Degree & above Source: World Bank calculations using Sri Lanka STEP Employers Survey. GCE A-levels, only 18 percent of the population has done 156. When it comes to vocational training, many so.51 Similarly, 70 percent of employers think that an aver- employers question the quality and relevance of ed- age low-skilled worker should have passed GCE O-levels, ucation and training curricula. Employers believe that but only 35 percent of low-skilled employees and 40 per- the TVET system could be critical for providing the work- cent of the self-employed have done so. About 60 percent ers they need but feel that it does not convey up-to-date of employers responding to a survey expected that an knowledge (50 percent) or produce the kinds (54 percent) average worker in a high-skilled occupation should have or levels (52 percent) of skills needed (Figure 4.14A). To completed technical or vocational education and training, compensate for skills shortages in the labor force many and 24 percent think the same about low-skilled workers. employers train their own workers. Yet only 16 percent of the population has that qualification (Figure 4.13). Similarly, 80 percent of employers expect a 157. The returns to education have been declining. high-skilled worker to know English and 40 percent expect Despite average educational attainment going up, the that of less-skilled workers while 75 percent of employ- premium to additional years of education has declined ers think an average higher-skilled worker should have over time (Figure 4.14B). This may be expected when over- computer skills and 38 percent expect the same of low- all average educational attainment increases without a er-skilled workers. However, only 20 percent of Sri Lankans commensurate increase in demand, leading to a decline are fluent in English and only 15 percent can use comput- in the premium from higher education. To demonstrate a ers. The supply and demand differences are less stark in mismatch between the demand for skills and the supply workers who are formally employed; the informal sector of education requires estimating returns to each type of lags seriously behind. skill under consideration, controlling for the increase in quantity of each such skill. However, to the extent that companies report shortages of well-trained workers, this decline in the returns to education is consistent with the view that Sri Lanka’s educational system is not providing 51  Based on the employer survey high-skilled workers are those who the skills desired by the market. This problem is particu- work as managers, professionals, technicians, and associate profession- larly worrisome for the youth, who often wait for years to als; low-skilled workers work in clerical support, services, sales, skilled agriculture, forestry and fishery, crafts and related trades, plant and ma- be admitted into university and then end up with degrees chine operation and assembly, and low skilled occupations. that provide relatively low returns. 70 | IV. Fostering Growth and Jobs for the Bottom 40 Percent Figure 4.15 R&D expenditure (percent of GDP) 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Korea Singapore China Malaysia India Hong Kong, SAR, China Pakistan Mongolia Nepal Thailand Sri Lanka Indonesia Source: World Bank WDI (Sri Lanka as of 2010). Table 4.1 Technology and development* Innovation Policies Availability Firm-level FDI and 158. Promoting innovation and entrepreneurship is of latest technology technology essential to increase the competitiveness of Sri Lanka’s technologies absorption transfer private sector. While many countries have sought to en- hance innovation through direct government support in Bangladesh 99 108 112 the form of subsidies and grants, the results and effective- China 97 68 81 ness of such programs have been mixed at best. Enhanc- ing innovation in Sri Lanka will likely require a long-term India 110 102 95 innovation policy that fosters linkages between domestic Indonesia 53 42 40 and foreign firms as well as between universities and R&D institutions and the private sector in Sri Lanka. An effective Japan 14 2 55 innovation policy will also eliminate costly barriers to im- Malaysia 33 24 8 ports of capital goods and be in line with policies aimed at attracting efficiency-seeking FDI. Mauritius 48 44 57 159. Different countries have adopted different in- Pakistan 85 83 90 novation policies and there is no one-size-fits-all ap- Philippines 58 41 31 proach. Sophisticated economies such as South Korea and Singapore have promoted R&D-driven innovation, Rep. of Korea 30 28 73 which leads to the introduction of products and processes Singapore 15 16 2 that are “new to the world” (Figure 4.16). However, invest- ment in R&D may not be efficient in absence of linkages Sri Lanka 70 53 53 between R&D institutions and networks of enterprises that Thailand 74 55 15 can benefit from it. Economies that have yet to catch up Vietnam 123 121 93 with more productive peers often implement policies that seek to accelerate the absorption of existing technologies Source: World Economic Forum (2015). that are “new to the country” as a way to enhance the pro- * See http://reports.weforum.org/global-competitiveness-report-2014-2015/ ductivity of existing industries (Table 4.1). Sri Lanka’s ex- economies/#economy=LKA Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 71 Figure 4.16 Proportion of firms using technology licensed from foreign edge institutions that effectively collaborate companies (percent) with the private sector. 161. Investment in, and quality of, R&D Angola has been insufficient to facilitate effective Panama modernization of agriculture. Sri Lanka St. Vincent has fallen behind in the generation of new Dom Rep knowledge and technology as well as in the Azerbaijan Serbia distribution of new technologies that are crit- Bosnia ical for modern farming. The percentage of Fiji the agriculture budget allocated for R&D and Turkey extension is small compared to other Asian Romania nations. The majority of the country’s 23 re- China search institutes focus on traditional sub-sec- Botswana tors and crops, including fisheries, rice, and Albania the plantation crops (tea, rubber, coconut, Belize Bulgaria sugar cane). Very little funding is allocated to Grenada higher-value crops (vegetables, fruit, dairy) Mauritius that are critical to driving sector moderniza- Jamaica tion and exports. In fact, only a small portion Argentina of the value of export cesses – which are sup- Ecuador posed to be the industry’s contributions to Algeria agricultural R&D (tea, rubber, coconut mainly) South Africa -- are given to the research institutes. These Colombia Mexico institutions focus on physical output of com- Dominica modities and less explicitly on profitability of Kazakhstan for its customers. At the same time, publicly Brazil run extension services are under-resourced Hungary and do not allow for effective diffusion of new Costa Rica technologies. R&D must shift towards a more Sri Lanka market-driven approach as farmers diversi- Macedonia, FYR fy their farming systems by producing more Jordan Peru high-value crops, livestock, and related prod- Belarus ucts. Sri Lanka would benefit from an overall Suriname reorganization of its R&D and extension sys- Venezuela tem, including promoting more private-sec- 0% 5% 10% 15% 20% 25% 30% 35% 40% tor participation. Source: World Bank WDI (Sri Lanka as of 2010). 162. Sri Lanka’s potential for innovation and scientific discovery is highlighted by penditure on R&D and formal transfer of technology has its output of intellectual property where it lags be- been modest compared to other emerging markets (Fig- hind some particularly dynamic countries (Figure ure 4.16). 4.17). Countries that have moved from middle-income to high-income status tend to show higher levels of pat- 160. Strengthening research and development and ent generation than nations that do not make the jump, promoting collaboration between academia and the and Sri Lanka is likely to need to follow the same path.52 private sector is critical. In the past the focus of govern- Sri Lanka has an intellectual property framework in place ment has largely been on income tax and VAT incentives to but it has scope for improvement.53 Beyond the legal boost R&D, particularly through government institutions. and regulatory framework covering intellectual property However, two constraints quickly emerged: (i) the small number of suitable government research institutions ca- pable of catering to industry needs; and (ii) the limited 52  Bulman D, Eden M and Nguyen H (2014) capacity in, and low-industry orientation of, government 53  See http://www.wipo.int/wipolex/en/profile.jsp?code=LK and research facilities. Raising overall public and private R&D http://reports.weforum.org/global-competitiveness-report-2014-2015/ is important but should be done in the context of knowl- economies/#economy=LKA 72 | IV. Fostering Growth and Jobs for the Bottom 40 Percent Figure 4.17 Applications for trademarks and patents per US$100 billion, 2013 (total count, by applicants origin) A. Applications for trademarks B. Applications for patents 12000 300 10000 250 No. per US$100 billion GDP No. per US$100 billion GDP 8000 200 6000 150 4000 100 2000 50 0 0 Bangladesh China India Indonesia Japan Malaysia Mauritius Pakistan Philippines Republic of Korea Singapore Sri Lanka Thailand Viet Nam Bangladesh India Indonesia Malaysia Mauritius Pakistan Philippines Singapore Sri Lanka Thailand Viet Nam Source: http://ipstats.wipo.int/ipstatv2/?lang=en rights, there is also scope to strengthen financial services governance -- is a priority for sustaining growth and ex- and support mechanisms to foster the commercialization panding employment opportunities for the population as of local inventions and improvements of technology and a whole and the bottom 40 percent in particular. production techniques. Public Sector Performance as a Regulator C. The Relationship between the 164. The investment climate in Sri Lanka lags behind Public Sector and Private Sector that of regional peers and is a significant drag on com- petitiveness going forward. Sri Lanka has made some 163. The relationship between the public sector and important reforms over the past years that have translated private sector has been a critical determinant of Sri into improvements in some areas of investment climate. Lanka’s development over the past few decades and However, most areas of the investment climate remain will shape its progress going forward. Global experience more challenging than in other regional and LMIC com- points to the importance of private-sector-led growth parators by several measures, including the Ease of Doing and government regulation to facilitate such growth. In- Business indicators (Figure 4.18). Going forward, sustain- dustrial, trade, and tax policies carried out by successive able private-sector-led growth will require the ability of governments – many of them extremely granular in nature the country to identify and eliminate unnecessary busi- -- have shaped the contours of Sri Lanka’s economy. The ness environment obstacles to entrepreneurship particu- government has also had a major impact on the economy lar to Sri Lanka. This will require more intensive public-pri- and jobs for the population through regulation of the pri- vate dialogue to involve the private sector in identification vate sector in terms of market entry and transactions, land of the most significant obstacles to their operations as a use, and labor practices. While all states regulate these is- way to prioritize reforms. At the same time, after reforms sues, particular features of Sri Lanka’s approach have led take place on paper, their full and consistent implementa- to specific types of constraints. Finally, the state itself is a tion across the country is essential to ensure equal oppor- major participant in the market through its large SOE sec- tunities for entrepreneurs in all regions. Finally, it will be tor and large public service, which in turn has impacted important to assess the impact of reforms to ensure that competitiveness in a number of sectors and labor market they have achieved the objective expected. dynamics. These government policies have contributed to the emergence of a large informal sector, which further Regulatory Environment: Land distorts the market and undermines productivity. Address- ing constraints evident in the present pattern of the state’s 165. Issues related to regulation of land are viewed interaction with the private sector – improving economic as a barrier to business development. Access to land Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 73 Figure 4.18 Comparison of rankings, Doing Business 2015 in large irrigation areas. The state has consistently avoid- ed outright sales of land. Pri- vate ownership of agricultural Enforcing Contracts land is restricted to 50 acres 200 per person. There is much Getting Electricity 180 Paying Taxes anecdotal evidence of a large 160 140 number of disputes over own- 120 Sri Lanka ership claims of land in both 100 Getting Credit 80 Registering Malaysia rural and urban areas. This is 60 Property 40 Vietnam caused by both incomplete- 20 ness and inconsistencies in 0 India past registration systems as Resolving Pakistan well as inheritance law, which Starting a Insolvency Singapore mandates the partition of Business Thailand land among successors. The Trading Across Protecting system for demarcating and Borders Minority Investors registering tenure rights to land parcels is fragmented Dealing with Construction Permits among institutions and there is a lack of provisions to re- solve disputes over claims to Source: World Bank Doing Business, 2015. land quickly and conclusive- Note: Higher ranking implies lower comparative performance ly. For these reasons, the vast majority of civil cases in courts was among the chief constraints to business cited in the taking more than five years to resolve (and in some cas- 2011 Enterprise Surveys, and land ownership issues are es stretching over decades) relate to partition and land the most common reason disputes.56 Contestation over ownership dampens invest- cited by informal firms that Land ownership do not register.54 While larger ment, reduces the efficiency of land markets and ultimate- ly undermines productive use of land assets. issues are the most firms – through the SDP, BOI, 167. Tenure and use regimes of most state-owned common reason cited can circumvent some of the and other special regimes – land by private parties are regulated by the Land De- by firms that do not difficulties in accessing land, velopment Ordinance (LDO). According to this ordi- register difficulties. In a survey of SMEs encounter significant nance originating from the 1930s, the state provides the right to occupy and use land in perpetuity subject to re- SMEs (2014)55, 62 percent of strictions on sale, lease and mortgaging and conditions on firms affirmed the complexity of land-acquisition proce- failing to use land productively. The provision of rights is dures, 65 percent reported that these procedures involve in two stages – first “permitted” for a short period of time high costs, and 65 percent also reported corruption in the and then “granted” as a right. Although there are few cases procedures. Doing Business also notes the difficulty in reg- of the government taking back land or denying alienation istering a property. of tenure rights to others, the latent possibility provides local administrators with discretion and deflates the value 166. The state owns most land, while privately owned of the land ownership rights. Under the LDO and through land is often subject to disputes over claims. Around 80 percent of land is state-owned, with the state owning other incentives associated with fertilizer subsidies, the all plantation land and common lands (forests, beaches, state regulates the types of crops that should be grown, etc.) and 55 percent of non-plantation cropland, mainly with particular attention given to ensuring rice produc- tion. Plantation land is handled through long-term con- cessions to large private companies or directly managed by state-owned agricultural enterprises. 54  de Mel et al (2013). 55  Wijesinha, A. and Ekanayake R. (2014), ‘Tax Policy and Enterprise De- velopment in South Asia – Sri Lanka Country Report’, Governance Insti- tutes Network International: Islamabad. 56  World Bank 2013 74 | IV. Fostering Growth and Jobs for the Bottom 40 Percent Figure 4.19 Percent of firms identifying business licensing and permits as a major constraint A. Cross country comparison B. Sector and regional breakdown 25 60 50 19.7 20 40 16.1 30 15 12.9 20 10 10 0 Other Services Garments Food Retail Other Manufacturing Southern Eastern North-Central Sabaragamuwa North-Western Uva Western Central Northern 5 0 All Countries South Asia Sri Lanka Source: World Bank Enterprise Surveys 2012 168. Finally, the predictability of state regulation are negatively affected, almost one in three manufactur- with regard to property rights has been impacted by ing firms are impacted. One in 100 firms in the Southern a few recent cases of controversial government legis- Province suffer from these difficulties, while they hamper lation. Most notable among these was an act introduced almost six out of 10 firms in the Northern Province. The in late 2011 under which private-sector projects on state uneven impact of investment climate deficiencies high- land deemed by the government to be abandoned, un- lights a potential gap between the written law and its ap- derused or being operated outside of the scope of the plication, which could stem from discretionary behavior of original agreements were returned to the state. The “Re- some regulatory agencies. The uneven application of laws vival of Underperforming Enterprises and Underutilized and regulations across regions could reinforce existing re- Assets Act” expropriated 37 enterprises in sectors like ho- gional growth imbalances and hurt employment creation tels, mixed-property development and sugar industries. in areas where more of the bottom 40 percent is located, While
the government
at the time stated this would be a like in the Northern Province. one-off measure, the law’s targeting of specific enterprises and language that provided for further takings spooked Regulatory Environment: Trade Facilitation business confidence. Similarly, in 2013 the government abruptly introduced legislation to restrict foreign owner- 170. Sri Lanka has seen steady improvement in its ship of land, including legal entities with foreign equity. ranking on international trade facilitation indexes al- Consultative mechanisms for private-sector inputs on spe- though its performance is still lower than the middle cific legislation that may affect the business climate are ad income and East Asian peers with which it currently hoc at best. competes. Sri Lanka’s performance on key international trade-facilitation indices are indicative of the strides the Regulatory Environment: Licenses and Permits country has made in improving its trade facilitation in the last five years (Figure 4.20). However current challenges 169. Licenses and permits are an obstacle to a greater involve the stiff competition being posed by other mid- degree than in comparator countries, with significant dle-income and South East Asian countries that are vying differences within the country. Almost one in five com- for a greater share of global investments. The perceptions panies responding to an enterprise survey in 2011 identi- identified in international indices point to significant im- fied licensing and permitting as a major obstacle to their provements that could be made to the regulatory and in- operations – as compared to close to one in 10 firms with stitutional infrastructure that currently exist in Sri Lanka. similar views in other countries. These investment climate difficulties affect firms unevenly across industries and re- 171. Bureaucratic bottlenecks have given rise to high gions (Figure 4.19). While one in 10 service-sector firms trade transaction costs. Policy-induced barriers consist- Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 75 Figure 4.20 Logistics performance index scores (2010-2014) Reform efforts (such as upgrading to the ASYCUDA World system) are also undermined by insufficient informa- tion and communication technol- Overall ogy capacity among the agencies 1 and failure to integrate the 30 gov- Quality of trade 0.8 Ability to track ernment agencies involved in trade and transport- 0.6 and trace facilitation through a single window related 0.4 consignments infrastructure 0.2 Sri Lanka facility. 0 Malaysia -0.2 172. Trade facilitation efforts will Frequency with -0.4 Competence Singapore benefit from increased coordi- which shipments and quality Vietnam nation among all government reach consignee of logistics Thailand agencies involved in the trade within scheduled services transaction process. In particular, Ease of arranging alignment with the World Trade Or- Efficiency of ganization-Trade Facilitation Agree- competitively customs clearance priced shipments ment, which will ensure a reduced process documentation burden for business- es, more streamlined procedures, application of risk-based controls, Source: World Economic Outlook, Central Bank of Sri Lanka increased transparency of informa- tion, regular stakeholder consulta- ing of regulatory and institutional bottlenecks account for tion and increased automation. Increasing coordination nearly 70 percent of the total time spent on exporting or among agencies -- with a fo- importing goods (Figure 4.21). The preparation of docu- cus on streamlining, harmo- ments is the most significant component, absorbing more nizing and simplifying border Increasing than 50 percent of the time spent on import or export clearance, legislation, policy coordination among procedures. The existence of two processes for BOI com- of government” perspective agencies handling and procedures from a “whole panies and non-BOI companies, onerous documentation requirements and the failure to update the outdated cus- through standard operating trade will improve toms ordinance are key issues that increase the complexity procedures, memoranda of the business of the regulatory framework governing trade in Sri Lanka. understanding, and coordi- nated decision-mak- environment Figure 4.21 Duration of procedures for imports/exports ing -- will improve the business environment. The establishment of the National Trade Facilitation Committee is a posi- 60 tive step in that regard. Moreover, clearance times Percentage of time spent are affected by a heavy inspection burden. There 50 is no legal provision for risk management as there 40 is a government decision that mandates 100 30 percent examination, a legacy from the conflict 20 period. Removing the regulation and applying 10 risk-based controls along with implementation of a streamlined and automated trade transaction 0 system (single window) will facilitate trade. Final- Document Customs Ports and Inland Preparation clearance and Terminal Transportation ly, given the complexity involved in regulating im- technical Handling and Handling ports and exports, increasing transparency in the control information provided both electronically through a trade portal and through regular consultations Policy induced barriers Logistics related barriers with trading firms would enhance accountability and improve information flow among stakehold- ers, leading to better trade-facilitation perfor- Source: WBG calculations based on data from www.doingbusiness.org mance. 76 | IV. Fostering Growth and Jobs for the Bottom 40 Percent Regulatory Environment: Labor Market governing maternity benefits59 make employers bear the entire cost, potentially deterring employers from hiring 173. Labor market regulations appear to be con- women.60 straining the growth of employment. Labor market regulations aim to provide job security to formal-sector Regulatory Environment: Enforcement of Contracts workers but, since these workers represent only about 15 percent of the labor force, the 175. Sri Lanka’s commercial justice system is prone Labor market regulations instead result in a to delays, though there have been improvements in deep divide between formal recent years. The country’s justice system suffers from a regulations slowed and informal workers. While it relatively small number of judges and corresponding high employment growth is relatively easy to hire work- caseloads, and lax enforcement of civil procedure, which outside of export ers in Sri Lanka, it remains leads to frequent continuations and gaps in law that make resolution of land and land inheritance disputes very dif- difficult for formal firms to production zones downsize during downturns. ficult. Recent controversies over leadership in the judicia- Sri Lanka’s Termination of Em- ry and executive influence have further undermined the ployment of Workmen Act (TEWA) requires that firms with sector. There is a backlog of over 25,000 civil cases lasting 15 or more employees justify layoffs and provide gener- more than five years (and, in some instances, more than ous severance pay to displaced workers, with smaller firms 30 years), the vast majority of which are land and partition being exempted. Moreover, severance payments are ex- (land inheritance) cases. Alternative dispute resolution has pensive relative to regional and middle-income peers. Al- not taken root, with the exception of community level me- though formally subject to TEWA, firms in EPZs may have diation boards. However, the introduction of a specialized been partially exempt from TEWA due to lax enforcement commercial high court in Colombo to hear higher value in that sector. Empirical work57 has shown that TEWA re- commercial cases has improved adjudication in terms of strictions retard the growth of non-EPZ firms below the timeliness and quality of judgments.61 threshold of 15 workers, only atypically productive firms pass the threshold, and once they do, they grow faster Regulatory Environment and Informality than EPZ firms, suggesting that the TEWA failed to lower unemployment. Instead, it slowed employment growth of 176. Regulatory compliance burdens prompt entre- non-EPZ firms and induced firms to seek the EPZ sector in preneurs to operate informally, which in turn under- order to evade the law. mines competition. Moreover, the level of informality is much higher in some sectors (such as non-garment man- 174. In addition, the legal framework governing work ufacturing, where one in three firms reportedly start oper- in the private sector reduces female employment. Leg- ations informally and stay informal for three years on aver- islation prevents women from taking up night work or age) and in some regions of the country (notably Eastern part-time work in the growing service sector.58 This not region where more than 60 percent of firms surveyed start only promotes exclusion of women from some economic operations informally and remained informal for almost sectors, such as the growing tourism industry, but it also seven years on average (Figure 4.22A). Informality affects reduces overall potential employment. Similarly, the laws the ability of firms to grow and enhance productivity due, inter alia, to limited investment, limited access to finance and inadequate business processes. 57  Abidoye, Orazem and Vodopivec (2009). 58  The Shop and Office Employees Act No. 19 of 1954 states under 59  Maternity benefits in Sri Lanka’s private sector are governed by the paragraph 10(2) that „a person who has attained the age of fourteen Maternity Benefits Ordinance No. 32 of 1939 (for women employed in any years and who [...] is a female, shall not be employed in or about the busi- trade) and the Shop and Office Employees Act No. 19 of 1954 (for women ness of a shop or office before 6 am or after 6pm on any day“. Exception employed in shops and offices) (Abeykoon et al. 2014). In 1993, Sri Lan- included in the act include: (i) women from the age of eighteen years may ka ratified the ILO Maternity Protection Convention (Revised) 1952 (No. be employed in or about the business of a hotel or restaurant for the peri- 103). However, there remain shortcomings between the national legisla- od between 6pm and 10pm; (ii) women from the age of eighteen may be tion and the ILO convention. One of the shortcomings is that maternity employed in a residential hotel before 6am or after 6pm; and (iii) women benefit payments are financed through employer liability. from the age of eighteen may be employed in or about the business of a shop or office for the period between 6pm and 8pm. See Shop and Office 60  Gunatilaka 2013 Employees Act accessed at: http://www.ilo.org/dyn/travail/docs/1350/ 61  Doing Business methodology uses a case which would fall under Shop percent20and percent20Office percent20Employees percent20Act. regular district court jurisdiction rather than the Colombo High Court. For pdf (April 1, 2015). broader discussion see World Bank Sri Lanka Trustree Sector Review (2013) Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 77 Figure 4.22 Regulatory compliance prompt entrepreneurs to operate informally A. The proportion of firms operating informally is high, particularly in B. Informal practices are a major obstacle to the growth non-garment manufacturing and in the North, East and Uva Province and competitiveness of established firms 70% Proportion of firms that start operations 8 16.0 informally 60% 7 14.0 Number of years firm operated without 6 12.0 50% formal registration 5 10.0 40% 4 8.0 30% 3 6.0 20% 2 4.0 10% 1 2.0 0% 0 0.0 All Countries South Asia Sri Lanka Retail Garments Other Services Food Other Manufacturing Small (5-19) Medium (20-99) Large (100+) Western Southern Central North-Central North-Western Sabaragamuwa Northern Uva Eastern Informal Practices Access to finance Tax rates Electricity Access to land Labor regulations Tax administration Business licensing Source: World Bank Enterprise Surveys 2011 stimulate collaboration between smaller informal firms Figure 4.23 Distribution of industries by number of and formal firms, investment in operational efficiency and establishments and persons engaged business growth.62 93% 178. Most business establishments in Sri Lanka are 100% small, with profound implications for productivity. An 80% important obstacle to improving firm-level productivity is the extent to which firms can take advantage of economies 60% 46% of scale. The 2014 Economic Census found that 93 percent 40% 26% of private economic establishments had fewer than 5 em- 19% ployees (Figure 4.23). Nearly 22 percent of those establish- 20% 4% 9% 3% 0% ments are in manufacturing, 0% while 70 percent are in the Micro (1-4 Small (5-9) Medium Large service industry, including There have been employees) (10-99) (100+) 40 percent in wholesale and overall increases in Share of establishments Share of employment retail trade, and 8 percent informal employment in hotel and food services. Source: DCS, 2015 Economic Census listing sheets. While the link between firm over the past decade size and productivity is not 177. Side-by-side operations of informal and formal documented in Sri Lanka, developing-country experience firms in a market lead to unfair practices and market would suggest that small firms tend to be less produc- inefficiencies. Unfair competition from informal players tive. Moreover, these micro firms are younger than large is viewed as the single most important obstacle to the enterprises, with an average of 10 years since beginning growth and competitiveness of established firms (Figure commercial operations against an average of 20 years for 4.22B). Formal firms may find themselves at a disadvan- medium and large firms. SMEs are particularly prevalent in tage as they face higher marginal costs, such as for labor regions outside the Western Province. and taxes, than informal firms. At the same time, informal firms generally have no access to financial services, gov- ernment contracts, and essential licenses and permits, and there is local evidence that greater formalization can 62  de Mel et al (2012). 78 | IV. Fostering Growth and Jobs for the Bottom 40 Percent Figure 4.24 Non agricultural employment A. Non-farm employment by type of work B. Private Sector Employment by Firm Size (share of total employment) (share of private sector employment) 100% 100% 7% 9% 7% 33% 34% 80% 21% 24% 21% 25% 37% 60% 8% 8% 32% 35% 31% 52% 23% 21% 18% 40% 16% 17% 18% 20% 14% 16% 17% 20% 18% 20% 19% 16% 16% 14% 0% 0% 2002 * 2003* 2004* 2005* 2006* 2007* 2008* 2009* 2010* 2012* 2011* 2006* 2007* 2008* 2009* 2010* 2012* 2011* Public Private formal No regular employees Working for household Private informal Self-employment Micro (1-4 workers) Small (5-9 workers) Other Medium (10-99 workers) Large (100+ workers) Source: Arunatilake et al (2015) based on Labor Force Survey data. Excludes Northern and Eastern provinces. 179. The proliferation of informal employment and permanent workers; one-third of that gap cannot be ex- small firms has important consequences for the ability plained by differences in the job or individual characteris- of the bottom 40 percent to share in the growth pro- tics, suggesting that to some extent workers would choose cess. Most of the increase in non-agricultural employment more stable jobs if they could.65 between 2002 and 2012 was among self-employed non- farm workers (accounting for 48 percent of the increase). 180. Under these circumstances, a key question is Self-employed workers increased from 21 to 25 percent of why firms stay informal in the first place and what non-agricultural workers between 2002 and 2012, while can be done to encourage formalization. A standard the share of informal-wage workers63 hovered above 30 hypothesis has been that reducing the cost of operating percent of the non-farm workers (Figure 4.24A). Moreover, a business could reduce informality, reduce uncompet- the decline in agricultural employment coincided with a itive practices, and, by extension, create an environment sharp increase in workers employed in establishments more conducive to investment in productivity-enhancing with no regular employees. By 2012, 37 percent of non- activities. However, existing evidence indicates that low- farm workers were employed in establishments with no ering the costs of formalizing on businesses would have regular employees, up from 33 percent in 2006 (Figure only limited impact.66 In fact, it appears that most informal 4.24B).64 Similarly, by 2012, 74 percent of unskilled workers firms will not formalize unless forced to do so via increased (those with less than a primary education) had only tem- enforcement, suggesting formality offers little private porary or casual wage employment, up from 70 percent benefit to informal firms. Similarly, rigorous evaluations of in 2006, suggesting that these workers are increasingly business training programs show limited to no effects on working under precarious conditions. Wages of temporary actual firm outcomes and performance.67 Even providing workers are on average 33 percent lower than wages of business training and grants have not yet been shown to 63  Informal workers were defined as by DCS as workers in companies not registered, those without accounts, or those with less than 10 regular 65  Arunatilake et al (2015). employees. This data is only available beginning in 2006. 66  See Bruhn and McKenzie (2013), Bruhn (2013), Mullainathan and 64  Although calculations presented here exclude the Northern and Schnabl (2010) and de Mel et al (2013) for evidence from Brazil, Mexico, Eastern province for comparability purposes, the share of workers in Peru, and Sri Lanka. establishments with no regular employees was also 47 percent in 2012 67  For a recent review of the literature, see McKenzie and Woodruff when the North and East are included. (2012). Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 79 encourage firms to formalize.68 Given this evidence, what Access to Finance policies should Sri Lanka focus on? 183. Despite ample liquidity in the banking sector 181. There are several compelling reasons to try and and declining interest rates, access to finance contin- bring larger and more profitable informal firms into ues to be a constraint reported by SMEs. Stalled growth the formal system. First, collecting taxes from relatively in credit to the private sector well-off owners of informal firms would widen the tax base, while the revenue collected is likely to justify the costs of can be tied to crowding out by the needs of the public Larger firms have easy sector – which utilizes almost access to loans and greater inspections to ensure that they do become for- mal. Secondly, these larger and more successful informal firms are more likely to be the ones competing with formal 50 percent of the domestic lower collateralization resources in the country. To improve the efficient alloca- requirements while firms for customers. Ensuring that such firms also become formal may cut back on unfair competition that prevents more efficient formal firms from growing faster. The chal- tion of resources in Sri Lanka, accessing finance is lenge is how to encourage formalization of such firms. the banking sector will need to become more compet- particularly difficult itive and efficient, and the for smaller firms and Based on the evidence described above, lowering the cost and complexity of registration seems a necessary, but not sufficient, step. Policymakers could also experiment with non-banking financial sector firms managed by women innovative approaches to encourage suppliers or custom- will need to be developed ers to demand formality. One such example being tried in to provide much-needed al- several countries is to link each tax receipt number to a lot- ternative options to the SME tery, so that customers have an incentive to demand a tax sector. In particular, accessing finance appears to be partic- receipt on each transaction. Such a system has been used ularly difficult for smaller firms, those operating in specific in Taiwan, China; Korea; China; and Puerto Rico. Wan (2010) sectors (including garments and retail), and firms man- compares changes in tax revenues in districts in China that aged by women. For those firms, accessing credit is often introduced this reform to those that did not, and finds the dependent on their ability to post collateral with a value of introduction of this tax receipt lottery increased sales tax more than 200 percent of the loan amount, a substantial revenue by 17 percent. obstacle for many firms (Figure 4.25). On the other hand, larger firms appear to have relatively easy access to loans 182. For subsistence enterprises, the existing evi- and much lower collateralization requirements. Although dence seems to suggest that such firms see no bene- a movable collateral registry is available, it is limited in its fits from formalizing, and would typically contribute operations, severely curtailing the ability of firms and en- very little to taxes if they did formalize. They may still trepreneurs to use moveable collateral (e.g. machinery, in- compete with larger firms, but in the absence of other job ventory, accounts receivable) as security to their loans. As opportunities for these individuals, the government may prefer to leave them alone rather than have them close down. The only remaining public rationale for trying to Figure 4.25 Access to finance difficulties driven by high bring them into the formal sector is that the presence of collateral requirements so many informal firms may send a message to the public that obeying the law is optional, and also dissuade more Firms identifying access to finance as a major constraint prosperous informal firms from formalizing. An alternative Value of collateral needed for a loan (% of the loan amount) approach used in some countries is to write the law in a 50% 250% 45% 225% 230% 226% way that does not require informal firms with income be- 213% 40% 194% 200% low a certain threshold to register, putting them in com- 35% 193% pliance with the law. But unless such a threshold is set 30% 150% 141% 138% very high, there are still likely to be many firms above the 25% 137% threshold who choose not to register. 20% 100% 15% 10% 50% 5% 0% 0% ale ale +) 9) g ts ) l -19 tai od rin en 0-9 00 fem m Re Fo ctu (5 rm (1 (2 r is all is ufa Ga e ium e rg er Sm ag an La ag ed an rM an M m m he p To p Ot To 68  See McKenzie and Woodruff (2012) for a review of the literature and de Mel et al (2012) for evidence on Sri Lanka. Source: DCS, 2015 Economic Census listing sheets. 80 | IV. Fostering Growth and Jobs for the Bottom 40 Percent a result, despite the high penetration of regulated financial funding from banks to finance investments in techno- institutions in Sri Lanka, an estimated 64 percent of micro, logical upgrading. There are also market failures in pro- small and medium enterprises remain without checking or viding business development services (BDS), to support savings accounts (World Bank, 2014e). improvements of SMEs’ management and business prac- tices (accounting, auditing, business planning, marketing, 184. Access to finance is most impacted by weakness- energy efficiency, etc.). While multiple public, private and es in the financial system and the bankability of proj- donor-funded initiatives have begun providing BDS across ects, while availability of funds per se is not a problem. the country, the majority of SMEs still indicate a lack of Past strategies to address this challenge have relied on awareness of such services, while certain critical needs of directed lending and concessional credit rather than im- SMEs (taxation advisory, market intelligence, digital tech- proving financial intermediation for, and bankability of, nology, etc.) are not being met by existing BDS providers72. SMEs. Sri Lanka has had numerous programs to enhance Rigorous evaluations focused on intensive technical assis- access to finance targeting specific sectors (including nine tance and subsidized consulting services find positive and for agriculture, 11 for SMEs, and seven for microfinance)69, significant impacts on productivity and return on assets in yet SMEs continue to highlight access to finance as a ma- the short run, and employment in the long run.73 jor constraint. Weaknesses in intermediation include: de- ficiencies in Sri Lanka’s credit infrastructure (the lack of a movable collateral registry and an incomplete credit infor- The State as Market Participant mation system); limited financial innovation (e.g. the lack of factoring, operational leasing of equipment); limited 186. Beyond its role as a regulator, the state has in- ability of, or incentive for, commercial banks to serve new creasingly become a direct participant in Sri Lanka’s markets segments (lack of cash-flow-based lending prac- economy. As described in the following two sections, the tices); and deficiencies in the legal framework governing state is an important participant through its SOE sector, lending activities (costly and long judiciary procedures for as well as through its role as an employer. Both of these foreclosure, and an outdated Secured Transactions Law)70. roles have an impact on the ability of the private sector The disconnect between extensive penetration of bank- to participate in the economy and have affected compet- ing institutions across the island and ample liquidity with itiveness in a number of sectors as well as labor market the difficulties that SMEs have in accessing finance points dynamics. to a lack of competitiveness in the banking sector overall. Financial institutions appear to be complacent with their 187. In playing its role in ensuring the provision of current client base and do not face market pressure to go public services and infrastructure, Sri Lanka’s govern- after the SME segment. However, further analysis is merit- ment has primarily used traditional procurement rath- ed to identify specific bottlenecks reducing the ability of er than seeking partnerships with the private sector creditworthy firms and economically viable projects from in the past decade. Investment in infrastructure over the getting financing, especially among SMEs (see Appendix past decade has been driven by public spending. While in 2.2. for more analysis of potential constraints). some cases this was tied to the terms of external financing for infrastructure, there was a policy of directly spending 185. Access to technology and business-develop- to build assets to be owned by the state. Of course, private ment services are additional constraints on SMEs. SMEs investment was not discouraged and there is cooperation find it difficult to access technology to upgrade their busi- in many sectors. Yet there are very few public-private part- nesses. A 2015 study showed that while access to finance nerships (PPPs), especially for the building or operation of was the foremost constraint (49 percent), the second infrastructure, under which the government would seek most-cited constraint by SMEs (23 percent) was access to to share risks and take advantage of private-sector financ- technology71. Much of the public and private technology ing know-how, and innovation. Even in instances where transfer institutions operate primarily or exclusively in Co- the government has recognized the need for private sec- lombo and there are rigidities in accessing project-based 72  Attygalle, K., D. Hirimuthugodage, S. Madurawala, A. Senaratne, A. 69  Central Bank of Sri Lanka Wijesinha, and C. Edirisinghe (2014), ‘Female Entrepreneurship and the 70  For example, long judiciary processes to foreclose collateral in case Role of Business Development Services in Promoting Small and Medium of borrowers’ default usually leads banks to request higher collateraliza- Women Entrepreneurs in Sri Lanka’, May 2014, IPS and OXFAM Interna- tion levels to cover for the additional costs associated. tional: Colombo. 71  Wijesinha, A. and N. Perera (2015), ‘Banking on SME Growth: Con- 73  See Valdivia (2012), Bruhn et al (2013), Bloom et al (2011) for evi- cepts, Challenges, and Policy Options to Improve Access to Finance in Sri dence on Peru, Mexico and India respectively. See McKenzie and Wood- Lanka’, March 2015, Working Paper Series No. 20, IPS: Colombo. ruff (2012) for a review of the literature. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 81 Box 4.3 Defining State-Owned Enterprises (SOEs) State-owned enterprises are a subset of what are legally defined as public enterprises. The Parliamentary Committee on Public Enterprises identifies six categories of institutions that fall under its oversight: regulatory bodies, promotional agencies, state-owned enterprises, educational agencies, development agencies and research institutions. There are about 240 entities that fall under the committee’s ambit, many of which are financed by the budget. Regular monitoring and reporting is carried out by the MoF for 55 larger SOBEs, which have commercial income. For the purposes of the SCD, the 55 SOBEs are referred to as SOEs. tor involvement and ownership, it is rare for the private range of sectors (Box 4.3). The 10 most important SOEs, sector to receive more than 50 percent ownership, which which account for about 90 percent of the asset base of all is often needed to attract quality operators wary of undue major SOEs, are financial institutions (Bank of Ceylon, Peo- state interference. Notably, private-sector power-genera- ple’s Bank, National Savings Bank, and Sri Lanka Insurance tion projects require partnership with the state. Corporation), major public utilities (Ceylon Petroleum Corporation, Ceylon Electricity Board, and the National 188. To date Sri Lanka lacks robust PPP legislation, Water Supply and Drainage Board) and logistics/trans- an institutional mechanism and capacity to plan, port service providers (Sri Lanka Ports Authority, Airport structure and implement PPP projects, and regulato- and Aviation Services, and Sri Lankan Airlines). There are ry structures to ensure public interests and investor other smaller SOEs in banking, public utilities and logistics concerns are balanced. Sri Lanka continues to lack the as well. Finally, the government has major SOEs in other necessary technical expertise to enter into large-scale PPP sectors, including construction, livestock, lotteries, media, projects in a transparent and mutually beneficial manner, marketing and distribution, plantations, pharmaceuticals, and many infrastructure industrial estates, mineral extraction, general trading and Sri Lanka lacks robust needs continue to be met by borrowed capital. Previous timber sales. Major SOEs accounted for nearly 17 percent of GDP in 2013 (Table 4.2). PPP legislation and attempts at creating institu- an institutional tional mechanisms for PPPs 190. SOEs play a significant role in Sri Lanka’s fiscal have been shut down. For balance. Transfers from the budget to public enterpris- mechanism to instance, the National Pro- es have averaged about 3 percent of total expenditures manage and regulate curement Agency set up in (around 50 billion LKR), mainly driven by direct transfers PPP projects 2004 with the aim of elim- and on lending to the Ceylon Electricity Board (CEB). The inating corrupt practices total debt of the 55 major SOEs accounted for approxi- and the wasting of time and mately 4.8 percent of total public debt in 2013. This num- resources, and improving transparency and efficiency in ber reflects reductions in debt thanks to conversions of infrastructure activities did not provide a framework for debt to government equity and capital infusions to strate- PPPs and in any case was eventually shut down in 2008. gic State-Owned Business Enterprises (SOBEs), which have Similarly, although a dedicated PPP unit in the BOI was set regularly occurred and were particularly large in 2013 up in 2006, it did not become a robust entity. As a result, (Ministry of Finance and Treasury). Sri Lanka lacks robust PPP legislation and an institutional mechanism to manage and regulate PPP projects. In fact, 191. Moreover, SOEs account for a significant share since 2009 publicly led investment was financed through of lending. The two largest banks in the country continue commercial borrowing in the form of Sri Lanka Develop- to lend a significant share of their funds to SOEs, including ment Bonds, sovereign bond issues, and other syndicated several that are loss-making or non-revenue-generating loans, along with bilateral loans at near-commercial rates, enterprises. In 2013, Bank of Ceylon (the largest bank by particularly from China. Much of the infrastructure com- asset base and lending portfolio, holding 20 percent of pleted post-war – two new ports, a new airport, roads and market share) lent 38 percent of its total portfolio to SOEs bridges island wide, two new expressways, and two new (primarily to Ceylon Petroleum Corporation, Sri Lanka power plants – have been financed through these chan- Ports Authority and Road Development Authority); and nels. People’s Bank (the second largest bank with 15.6 percent market share) lent 28 percent of its total portfolio to SOEs 189. At the same time, the state is a major participant (with high exposure to Ceylon Electricity Board, Ceylon in economic activities through a substantial SOE sec- Petroleum Corporation, and Ceylon Fertilizer Company tor. There are 55 major SOEs enterprises covering a wide Ltd). Since these banks account for a large share of the 82 | IV. Fostering Growth and Jobs for the Bottom 40 Percent Table 4.2 Sector wise performance of asset base of state owned business enterprises Sector No. of SOBEs Asset Size Percent of GDP Year on Year Growth Market Share (Rs. Billion) (percent) (percent) Energy 2 1,007.25 7.99 6.6 94 Water 1 242.60 0.21 9.5 44 Port 1 299.80 0.42 20 60 Commuter Transportation 1 14.52 0.31 9.2 23 Aviation 3 45.74 1.62 3.12 61 Construction 3 30.96 0.30 (17.24) 2.9 Banking & Finance 9 3,102.50 4.04 14.2 41 Insurance 4 154.60 0.39 8.6 27 Lotteries 2 7.77 0.28 1.97 100 Livestock 2 7.63 0.09 10.74 13 Plantations 7 12.63 0.11 (15.97) 3.72 Non-renewable energy 3 3.31 0.02 11.07 0.9 Health 4 18.62 0.28 (1.59) 27 Media 3 8.86 0.07 2.67 32 Marketing & Distribution 10 77.47 0.49 5.43 4.3 TOTAL 55 5,132.26 16.62 11.60 - Source: Annual Report 2013, Ministry of Finance & Planning banking industry, this high SOE exposure could reduce 193. The large SOE sector is largely a legacy issue. funding available to the private sector and expose the Most major SOEs were established in the 1960s and 1970s, banking sector to systemic risks given the precarious fi- with some -- notably the largest state bank, the Bank of nancial positions of the concerned SOEs. Ceylon -- founded prior to independence. In the past 15 years, the state has set up six new enterprises: three small 192. SOEs have a significant market share in many banks, one insurance company, a trading company, and sectors, including areas where there is not a strong ap- a new airline (which recently was merged with the other parent rationale for public intervention. While public state-owned airline, Sri Lankan Airlines). Thus, while the ownership of utilities and major infrastructure can be war- SOE sector is large, it has not been growing substantively, ranted to oversee natural monopolies or address free/easy with the partial exception of entrants in the finance sector. rider problems, a significant number of major SOEs remain Many of the SOEs reflect earlier, more statist policies, such in sectors that do not obviously have these features (Table as the state plantations that were nationalized in the early 4.2). This is most striking in the finance sector, where major 1970s. SOEs make up close to half of the market. While the overall market shares are less significant, SOEs also are important 194. Efforts to restructure SOEs were undertaken in several agricultural subsectors. One rationale common- during the 1990s and early 2000s and reversed after ly provided for commercial SOEs is that state intervention 2005. In the mid-1990s, the government launched an ef- is warranted to ensure service or provide employment to fort to reform underperforming SOEs, setting up the Pub- remote populations where the private sector is not active, lic Enterprise Reform Commission (PERC) to carry out this but there is little evidence to demonstrate this necessity. work. Under the aegis of PERC, privatization took place Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 83 in varying degrees, affecting 86 SOEs in the electricity in- 196. Sri Lanka has had a diffuse arrangement for dustry, telecoms industry, ports, agriculture, and the na- overseeing SOEs, complicating strategic management. tional airline.74 The post-2005 government had an explicit At the highest level, the Parliamentary Committee on anti-privatization policy that in some cases led to rever- Public Enterprises oversees financial and operational per- sals of past privatizations.75 The government of the past formance of SOEs through an annual review mechanism. nine years sought to make SOEs perform better, includ- More operational oversight responsibility for major SOEs ing through the establishment of the Strategic Enterprise has been shared between line ministries and MoF, through Management Agency (SEMA), which focused on 20 of the its Department of Public Enterprises. The line ministries most important SOEs. have in turn appointed members of boards of directors of SOEs in accordance with the 195. Following the end of the conflict in 2009, the relevant legislation for gov- The system of SOE military initiated business enterprises, though the scale of this activity is difficult to measure and its fu- ernance of a given SOE (i.e. the Companies Act or act oversight does not ture is unclear. Most notable among these are tourism establishing the SOE). SEMA easily provide for and associated businesses that are widely advertised. and a similar Strategic Re- making strategic The Sri Lanka Army76 now runs at least six tourist hotels source Management Com- across the country, while the Sri Lanka Air Force77 runs a mittee were separately set decisions golf course, two tourist hotels, and two banquet and con- up to provide managerial support, although reforms are vention halls. It also operates a civilian passenger airline mooted to bring SEMA into the MoF. None of these entities service, a veterinary service, and a hair salon in Colombo. appear to have had oversight over enterprises launched Meanwhile, the Sri Lanka Navy78 operates a whale-watch- by the military.79 This decentralized model complicates ing boat service, a restaurant in Colombo, three wedding holistic oversight of SOEs’ performance and management and convention halls, and seven tourist hotels across the of financial risk. In particular, critical information on eco- country. In addition to tourist activities, the armed forces nomic and financial performance, such as return to equity have been engaged in agricultural farming (specifically in and overall contingent liabilities of SOEs, are not system- lands belonging to families in the North), vegetable distri- atically tracked. SOEs have de facto considerable discre- bution, running small shops and cafes (mainly along trans- tion to set their own policies and strategies, including in port routes to the North), civil construction works (mainly sensitive personnel areas. The system also does not easily for Colombo urban upgrading projects), and conducting provide for making strategic decisions to maximize value “leadership training” at military camps for university en- to the state of SOEs or management changes such as re- trants. These initiatives were tied to the 2005-14 govern- structuring. The new government has indicated a change ment, calling into question the extent to which they will be of course through consolidation of oversight by establish- continued under a new government. ing a specialized ministry for SOEs, but its impact remains to be seen. 197. There is strong political involvement with SOE 74  The Public Enterprise Reform Commission, established by Act No. management. SOEs have requirements for the profile of 1 of 1996, was mandated to improve efficiency in the economy, increase its board directors spelled out either in their founding cct government revenue and motivate the private sector, but not explicitly to divest from and privatize SOEs. Nevertheless, divestiture did generate or more general guidelines, with a MoF representative al- over $500 million between 1995 and 1998, attracted a further $400 mil- ways present. But given the direct subordination to par- lion in foreign inflows, and private investments in the gas, steel, telecoms, ticular ministries, practice is that a change of government plantations and civil aviation sectors. automatically triggers the resignation of boards and the 75  Sri Lankan Airlines Sri Lanka Insurance, Waters Edge and Shell Gas appointment of a new board. The political connections were some of the key privatizations that were reversed, with the govern- of SOEs can lead to management decisions based on ment re-acquiring full ownership. non-commercial criteria. Most important, the closeness of 76  Lagoon’s Edge (Nanthikandal), Thalsevana (Jaffna), Laya Safari (Yala), Laya Waves (Kalkudah), Laya Beach (Wadduwa), Laya Leisure (Kalutara) political connections increases the likelihood of SOEs re- ceiving preferable treatment. 77  Marble beach (China Bay, Trincomalee), Eagles’ Golf Links (Trin- comalee), Eagles’ Heritage Golf Club (Anuradhapura), Eagles Lakeside Banquet and Convention Hall (Colombo), Eagles’ Lagoon View Banquet 198. The size, profile, and management framework Hall (Katunayake) for SOEs can negatively impact Sri Lanka’s competi- 78  Lagoon Cabanas (Panama/Arugam Bay), Sober Island Resort (Trin- comalee), Weligambay Villas (Mirissa), Club House (Uswetikeyyawa), Dambakolapatuna Rest (Dambakolapatuna), Fort Hammenheil (Jaffna), Golf Link Hotel (Trincomalee), Reception Hall (Ranminithenna), Recep- 79  For instance the most recent 2013 COPE report does not cover mil- tion Hall (Poonewa), Lake Front Rest (Kantale) itary enterprises. 84 | IV. Fostering Growth and Jobs for the Bottom 40 Percent tiveness. The concentration of assets under management continues to represent the largest share of formal workers. that is prone to politicization can lead to unproductive uti- lization of the country’s assets. It also likely dampens com- 201. Public-sector workers not only enjoy the benefits petition in key sectors; even if there has been basis for the of formal employment, but they also tend to earn more state’s involvement owing to the absence of market actors, than their private-sector counterparts. Public-sector SOEs will discourage future entrants. There is no formal workers have access to a non-contributory public pension mechanism to verify that there is a public purpose ratio- system (see Chapter III), paid vacations, and importantly, nale for individual SOEs. In the context of the no-privatiza- reduced work hours relative to private-sector counter- tion policy in recent years this has meant that the sector parts. Moreover, public sector hourly wages were on aver- continues to play an outsized role. age 40 percent higher than private sector wages in 2012. Part of the wage gap can be explained by differences in individual characteristics, since public-sector workers tend The Public Sector as Employer to be more educated. However, decompositions show that there continues to be a wage premium for public workers 199. Strong demand for public-sector jobs has met that cannot be explained by observable inividual charac- the increased supply of such jobs. As was discussed in teristics. In fact, 14 percent of the difference in wages be- Chapter II, there has been a 57 percent increase in pub- tween public and private workers cannot be explained by lic-sector employment (public service and semi-public en- observable differences (Figure 4.27A). The evidence sug- tities) over the past 10 years. This has met with steady de- gests that there is a premium to public-sector work, and mand from the population for public-sector jobs, despite that this premium has grown between 2006 and 2012. the private-sector growth and the consequent demand for labor. Data on the total applicant pool for various public- 202. To the extent that public-sector employment is sector jobs is not available, a growing share of total formal employment, this has There has been a 57 but the example of the Sri repercussions for the wage premium for private-sec- tor formal workers. Indeed, private formal wages were Lankan Administrative Ser- percent increase vice – admittedly a highly on average 35 percent higher than informal wages. in public-sector prestigious service – indi- Decompositions again show that there is a 6 percent pre- mium to formal-sector employment, after accounting for employment over the cates the attractiveness of public-sector employment. differences in characteristics and the types of jobs typical past 10 years For the period 2008-13, there was an average recruitment Figure 4.26 The composition of wage employment has of 163 people per year from an average pool of over 20,000 shifted towards the public sector (share of total wage workers) applicants, of which slightly more than half actually sat for exams. Only the engineering and scientific services experi- ence difficulties in recruiting staff. Moreover, the vast ma- 100% jority of public servants stay in the service until retirement. 90% 200. While overall wage employment has declined in 80% 50% 50% 48% favor of self-employment, the composition of wage em- 70% ployment has shifted towards the public sector. Overall 60% 77% wage employment declined from 58 to 56.4 percent of the 50% workforce between 2002 and 2012 in favor of self-employ- ment. This decline in wage employment was accompanied 40% 26% 23% 25% by a decline in the share of private-sector wage employ- 30% ment throughout the decade; it fell from 77 to 74 percent 20% of total wage employment between 2002 and 2012 (Figure 10% 23% 25% 27% 26% 4.26). In contrast, public employment increased from 23 to 0% 26 percent of wage employment when looking at com- 2009* 2010* 2011* 2012* 2002 * 2003* 2004* 2006* 2007* 2008* parable districts. Given the growth of the workforce, this seemingly small percentage increase meant an increase of over 95,000 non-farm public workers between 2006 and 2012, peaking at 27 percent of total wage employment in Public Formal private Informal private 2009 when large numbers of men joined the armed forces (Figure 4.26). Since then, public employment relative to all Source: Arunatilake et al (2015) using LFS formal-wage employment has declined somewhat, but it *Excludes Northern / Eastern provinces for comparability. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 85 Figure 4.27 Public and formal sector workers earn more than their private sector counterparts A. Public-private wage gap decompositions B. Formal-informal wage gap decompositions 60% 51.5% 60% 50% 43.9% 40.3% 40% 40% 35.3% 30% 20% 20% 10% 14.0% 11.0% 6.6% 6.3% 0% 0% 2006 2012 2006 2012 Difference between public and private workers Difference between formal and informal workers Characteristics of public workers Characteristics of formal workers Characteristics of private workers Characteristics of informal workers Unexplained public sector premium Unexplained formal sector premium Source: Arunatilake et al (2015) based on Labor Force Survey data. Excludes Northern and Eastern provinces. of formal and informal workers (Figure 4.27B). Together 203. In fact, the evidence shows that workers, partic- this lends some credence to the argument that markets ularly educated women, are queuing for public-sector are segmented, particularly for wage workers who would employment. The share of new job seekers looking for likely prefer formal public sector jobs but are rationed out public-sector work increased between 2006 and 2012, or excluded. To the extent that public- sector employment mostly on account of women. The share of women look- offers better working conditions for certain types of work- ing for work for the first time who specifically sought pub- ers, the private sector will find it difficult to compete for lic-sector employment increased from 25 to 31 percent be- the best workers. tween 2006 and 2012 (Figure 4.28A). Most of this increase Figure 4.28 Workers are queuing for public sector jobs A. First time job seekers by type of job sought B. Unemployed women expecting a public sector job (share of all first-time job seekers) (share of unemployed women) 40 60 35 50 30 40 25 30 20 15 20 10 10 2006* 2007* 2008* 2009* 2010* 2011* 2012* 2006* 2007* 2008* 2009* 2010* 2011* 2012* All women Below secondary (below A/L) Total Male Female Ages 15-24 Post secondary (A/L & above) Source: Arunatilake et al (2015) based on Labor Force Survey data. Excludes Northern and Eastern provinces. 86 | IV. Fostering Growth and Jobs for the Bottom 40 Percent Box 4.4 State intervention in agriculture Sri Lanka’s government plays a particularly large role in agriculture, consistent with inward-oriented policies, inefficient land markets, and a large SOE sector, which, together, create distortions. Agricultural trade and price policies. Sri Lanka’s agricultural policies have encouraged import substitution of basic agricultural commodities. Border taxes on imports and exports of agricultural products and tradable agricultural inputs have to generate fiscal revenue, support farmers engaged in import-competing activities and tax producers of export-oriented products. Import duties,and other taxes at the border yield nominal protection rates for importables for most agricultural products in the order of 30–50 percent. For rice, the total protection rate was 34 percent in 2011, making it a highly protected crop, mainly as result of fertilizer subsidies. Maize, potatoes and milk are highly protected as well. Exports of tea and rubber are taxed at low rates. The high protection of importables has created strong disincentives for crop and export diversification, providing support to expand production of import-competing crops (rice, maize) and discouraging the production of exportables. While agricultural export promotion is highlighted in various policy statements, Sri Lanka’s trade policy is overly complex and slows rather than accelerates export growth. Protection also results in inefficient use of public resources, and does not benefit smallholders as intended. Additional distortions are created by land-use restriction and policies that target subsidized fertilizers for particular sectors, such as paddy. The distortions affect producers and consumers. Rice producers gain at the expense of consumers. Income from paddy farming is estimated to be 36 percent higher than what it would be without government intervention. Similarly, incomes from potato and milk production are significantly higher while the policy impact on incomes from tea and rubber production is insignificant. Coconut farmers, on other hand, experience significant income reductions due to export taxes. The aggregate effect on agricultural income in absolute terms depends on the levels of production of all crops and the crop mix fostered by the incentive structure. Current policies represent an implicit tax on consumers of about 300 percent on maize and chili, 96 percent on milk, 54 percent on potatoes and 12 percent on rice. Land tenure and rural land markets. Sri Lanka’s current land tenure policy, which restricts use rights and transferability, depresses returns to land and the absence of a functioning rural land market constrains long-run sector performance. Smallholder farmers are, in essence, prevented from mobilizing one of their most important assets for promoting much-need investment into an under-funded under- invested sector. While government policy has aimed at equitable distribution of land, it has also fostered and perpetuated smallholder agriculture. Land legislation and settlement administration have successively limited farm size and constrained the rights of both owners and operators. Population pressure and inheritance practices have caused substantial fragmentation, leaving average farm-size well below the public- sector-irrigation-scheme norm of one hectare. Overall, 72 percent of farms are below one hectare. In the absence of a rural land market, irrigation-scheme settlers wishing to exit agriculture face a choice of abandoning a valuable farm or entering the uncertain informal market while market-based land consolidation necessary for productivity growth remains depressed. Functioning land markets would allow farmers to adjust size to respond to changing commodity prices and increased risks. The key to making this work is secure tenancy agreements and a stronger leasehold market. For public- sector land, long-term leases with provision for easy transfer would be a major improvement. For private-sector land, mechanisms to resolve title disputes through administrative and legal means as well as incentive systems are an immediate necessity. Legislation and programs to establish public- and private-sector institutions and professions to facilitate development of land markets are also required. The government should seek to unlock productivity potential in rural areas, particularly given the importance of the sector for poverty reduction. Sri Lanka’s low productivity levels – and the lack of incentives for farmers to improve productivity – call for renewed attention to basic investments in technology, extension services, irrigation, and market infrastructure. They also call for adjustments in the broader enabling policy framework to foster diversification and productivity and improve export competitiveness. This will not only include investments in restoring and further upgrading the country’s productive infrastructure, facilitating market linkages, and introducing modern agricultural technologies but also creating a policy environment that favors the expansion of the private sector, especially SMEs, and allowing for more flexibility in the rural land, labor and capital markets. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 87 is due to women with post-secondary training looking for 205. This interconnectedness points to political econ- public employment. That size of that group increased from omy factors that support a continued large role for 42 to 52 percent of all wom- government in the market. Given that there are frequent en looking for employment instances of state regulatory help to a given sector, it fol- Educated women between 2006 and 2012, lows that private sector entities would seek to maintain in particular are when looking at compara- or expand privileges, reinforcing the level of regulatory intervention into the economy. At the same time, it also increasingly looking If the Northern and Eastern ble samples (Figure 4.28B). suggests that many private-sector entities would have to for public sector provinces are included, this adjust considerably to succeed in a more open, competi- employment share increases to about 54 tive market. Combined with broader expectation of pub- percent. Indeed, many work- lic-sector employment, a reduction of the state’s role or ers, particularly women, are an attempt to “level the playing field” will encounter resis- in fields of study that put them on a path to public-sector tance from vested interests. employment. Since science and mathematics pass rates are poor in secondary schools and there is relatively little access to schools offering A-level science streams, many D. Priorities for Fostering More are compelled to study humanities if they want to go on and Better Jobs for the Bottom 40 to do A-levels. As a result, the most popular career streams are often not the ones where there is the highest demand Percent for labor. For instance, there are too many studying hu- manities instead of subjects that would position them for Promote Export-Led Growth jobs in the booming areas of tourism, finance, etc.). 206. Review and revise the country’s trade-relat- Interconnectedness of Public and Private Sectors ed policies to promote economic diversification and shared growth. This could include reforming the pa- 204. There is a high degree of interconnectedness ra-tariff regime to encourage more foreign trade. It also between the state and at least segments of the private likely would entail revisions to the tax system, in line sector that contributes to the degree of intervention with addressing fiscal constraints, to reduce the degree by the government. The variation in tax and customs of protectionism, particularly for targeted small sectors. incentives reflects government policy but those varying This would include simplification of the VAT and corpo- incentives also contain specific benefits for specific sec- rate-income-tax regimes and the reduction or elimination tors, which have a limited number of major actors. In addi- of cesses on agricultural commodities. Reductions would tion, there are several high-profile cases of senior officials need to be considered in the context of whether the incen- moving between public and private sectors. For instance, tives are achieving the desired objective. Finally, a contin- the state frequently uses ued focus on improving the trade facilitation and logistics environment, including streamlining licenses and permits There is no developed in commercial banks to ap- its various shareholdings required to export, would help to promote export-led framework for point members to boards of growth. handling conflict of directors, and in the process, 207. Provide for more resources and quality-enhanc- several current government interest officials and former central ing management in the education sector to ensure that the population (and especially the youth) has the bankers have been appoint- skills demanded by efficiency-enhancing enterprises. ed. Meanwhile, pension funds managed by the Central This could include steps to: ensure high-quality general Bank – the banking regulator – began investing in several education and development of soft skills; enable greater financial sector firms in recent years. At the same time, ma- private-sector participation in higher education, improve- jor business figures have in a few instances taken up senior ments in technical and vocational training and better co- positions in government in recent years. There is no devel- ordination with potential employer needs; and ensure that oped framework for handling conflict of interest to police young people are inclined to pursue degrees in the indus- the boundary between public sector employment and pri- tries where demand is highest. vate sector interests. The politically appointed boards of SOEs also serve to reinforce networks of influential public 208. Promote innovation by establishing linkages be- and private sector players. tween R&D institutions and networks of entrepreneurs 88 | IV. Fostering Growth and Jobs for the Bottom 40 Percent that can benefit. Development adaptation and better dis- for investment-climate reforms to unleash firms’ potential semination of technologies that fit Sri Lanka’s economy is should stem from regular dialogue between the public important for productivity growth. R&D institutions need and private sectors. to be oriented towards filling this role. This may, in part, be helped by encouraging more private-sector involvement 210. Review the role and participation of the public directly in R&D as well as in setting priorities for public-sec- sector in the economy. Stronger management and stra- tor institutions. This is a particularly important issue for ag- tegic oversight of the SOE sector is important to ensure riculture. that state involvement is serving a public purpose, does not create unwarranted fiscal risk and public assets are effectively utilized. The state should also take steps to en- Rebalance the Role of Public and Private Sectors sure that the public service is “fit for purpose” to carry out to Promote Private-Sector Led Growth public-sector functions and not as a mechanism for job creation. The state can play a role that facilitates greater 209. Improve the regulatory environment to allow private-sector involvement through the establishment of firms to grow, reducing informality and allowing for a robust institutional framework for public-private part- economy-wide increases in productivity and allow nerships to ensure public interests and investor concerns firms to reach as firms can reach economies of scale. are balanced while crowding in private-sector investment Some aspects of the regulatory environment that appear and skills. Finally, measures to address conflict of interest to be significant obstacles are: upgrading the systems for could reduce negative impacts of the interconnectedness land tenure and land use planning in both agricultural of government with specific businesses. and rural areas; modernizing labor legislation to encour- age easier movement of labor and female labor participa- 211. These measures together will help provide an tion; ensuring that the burden of business licensing and environment conducive to efficiency- and productiv- permitting is minimal, particularly in regions where this ity-enhancing FDI, allowing for less emphasis on tar- is a problem, such as the North; and providing for speed- geted incentives. A predictable, private-sector-friendly ier resolution of commercial disputes and enforcement regulatory environment and a skilled labor force can con- of contracts in court or using alternative dispute mecha- tribute to attracting and retaining FDI. Sri Lanka’s incen- nisms. Bringing larger and more profitable firms into the tives regime may need to be revamped as its competitive- formal system and improving enforcement could help ness improves and as streamlined investment policies and formalization efforts. However, the definition of priorities regulations are adopted and implemented. KEY KNOWLEDGE GAPS ■■ Analysis of the tradeoffs in reducing tariff protection given the low revenue base. This analysis should also in- clude potential impacts on employment in the absence of concurrent changes in labor legislation and other measures to reduce the cost of doing business. ■■ Analysis of firm productivity, entry and exit, and survival of firms, taking advantage of the results of the first economic census of economic establishments. Such analysis could allow for a better understanding of the main barriers to the establishment and growth of firms. ■■ Analysis of the school-to-work transitions of young workers, with an emphasis on cognitive and non-cognitive skills, aimed at identifying policy options to bolster employment and labor force participation. ■■ Analysis of bottlenecks reducing the ability of creditworthy firms and economically viable projects from getting financing, especially among SMEs. ■■ Analysis of migration and mobility – both internal and external -- to identify potential constraints to labor mo- bility. Analysis of remittances, their sustainability, and their use. ■■ Analysis of regional trade opportunities and steps to take advantage of such opportunities to capitalize on Sri Lanka’s comparative advantages. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 89 V. SOCIAL INCLUSION FOR SHARED PROSPERITY AND POVERTY REDUCTION 90 | V. Social Inclusion for Shared Prosperity and Poverty Reduction KEY PRIORITIES ON INCLUSION ■■ Using urbanization to drive inclusion. This is enhanced if there is a governance framework that empowers local decision-making responsive to the needs of the poor and bottom 40 percent for public services and infrastruc- ture. ■■ Multi-sector interventions to improve public service provision and promote employment opportunities in areas where poverty is localized -- including the Northern and Eastern provinces, Moneragala and the Estates; empha- sis should also be devoted to reducing nutritional deprivation. ■■ Promoting reconciliation and efforts to improve equality of opportunity across ethnic groups. This includes pro- moting employment opportunities, addressing land claims in the former conflict areas, providing assistance to new and former internally displaced persons (IDPs), and integrated efforts to assist widows and ex-combatants. ■■ Increasing female labor force participation by: increasing education and better aligning the education women pursue and the demands of the market; making changes to legislation that prevents or deters women from being hired; and promoting greater participation of women in leadership positions. Dimensions of Inclusion A. Inclusion across Space 212. As is true with many countries, there are four di- Spatial Concentration of Poverty mensions of social inclusion that are important in Sri Lanka: inclusion across space, ethnicity, gender and 214. The highest numbers of people living in poverty youth. Constraints in each of these areas preclude the and the bottom 40 percent are located within the Kan- ability of large population groups from fully participating dy-Colombo-Galle multi-city agglomeration, followed in shared prosperity. More generally, intersecting identi- by the other single city agglomerations. In fact, the spa- ties can produce a multiplication of disadvantage. For in- tial distribution of the poor and vulnerable -- in absolute stance, the intersection of ethnicity, gender and location numbers – across Sri Lanka has come to more closely mir- (or youth and location) can lead to increased negative ror the spatial distribution of the overall population, lead- effects. This section seeks to define areas where lack of ing to an increase in the relative concentration of poverty inclusiveness is evident. It must be noted that these prob- around the country’s main urban areas. The highest num- lems can be addressed through specific interventions and bers of people living in poverty and vulnerable to poverty especially by actions to provide for equal opportunity of are located within the Kandy-Colombo-Galle multi-city ag- participation for all segments in society, the economy and glomeration, followed by other single city agglomerations politics. Opportunities for participation should be promot- (Figure 5.1). ed alongside efforts to provide for effective public-sector management and growth through competitiveness de- 215. The concentration of poor in more dynamic ar- scribed in the previous two chapters. eas of agglomeration point to the importance of cities in further poverty reduction. Almost 50 percent of both 213. The importance of addressing exclusionary con- poor and vulnerable popula- straints is heightened by Sri Lanka’s recent history of tions are within 30 km of an Almost 50 percent internal conflict. Conflict negatively affected the entire agglomeration (Figure 5.2).80 country and specific segments of the poor and bottom 40 Therefore, efforts to improve of both poor percent in particular. As noted earlier, it is estimated that economic performance in and vulnerable the cost of internal conflict in the period 1978-2002 was roughly 5 percent of GDP per annum. Not surprisingly, the order to reduce poverty, such as those discussed in populations are highest levels of poverty and weakest equality of opportu- Chapter IV will directly ben- within 30 kilometers nity are in the areas most affected by conflict, the Northern efit these populations. A key of an urbanized area and Eastern Provinces. Not all ways in which exclusion has challenge is how to manage occurred in Sri Lanka directly fed past internal conflicts, nor was exclusion the only driver of conflict. However, many observers, including the LLRC, have noted that manifesta- tions of exclusion played an important role in sustaining 80  Poverty measurement is based on per capita consumption and the national poverty line. Note that the poverty line will need to be updated internal conflict in the country. Addressing the need for an soon given that the basket of goods being used corresponds to the 2002 inclusive society, economy, and polity is crucial for sustain- basket. Similarly a more ambitious poverty line may be desired in line ing peace and security. with Sri Lanka’s middle income status. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 91 Figure 5.1 Spatial location of overall population, poverty and the bottom 40 percent Source: World Bank staff and GIS analysis using 2012 Census and HIES 2012/13. the growth of the Kandy-Colombo-Galle agglomeration, ness given their proximity to markets. This chapter focuses in particular, the Metropolitan Colombo Region, and how on the North and East, the estate sector, and Moneragala to increase other single-city agglomerations, given their district. These are areas with a long-term inclusion chal- potential and implications for economic growth, compet- lenge that is different from the one confronting poor areas itiveness and poverty reduction. Streamlining urban man- located near centers of economic activity. agement structures and improving their capacity to ensure they have the administrative powers to deliver functional urban services and conduct integrated, strategic planning Figure 5.2 Share of national poor and vulnerable within (including land-use planning and transport planning) will 30km of all agglomerations provide local authorities with the opportunity to respond to both present and future needs. Share of total national 6% Jaffna, Trincomalee population and Batticaloa 216. However, these interventions will need to be complemented with others targeted to assist the poor Share of national 9% in more isolated regions of the country. As noted in vulnerable (bottom 40%) Chapter II, portions of the Northern and Eastern Provinces Share of national poor 11% stand out as regions with high concentrations of poverty (official poverty line) (Figure 5.3). This is true both for monetary and non-mon- Share of total national etary measures of poverty such as education, nutrition, 52% population Kandy, Colombo, Galle Corridor and access to services. Areas with higher poverty rates Share of national also tend to have a high share of the bottom 40 percent. 42% vulnerable (bottom 40%) In addition, two districts (Nuwara Eliya and Badulla), which Share of national poor make up a large portion of the estates, are home to 10.7 38% (official poverty line) percent of the poor population. The analysis and recom- mendations in the preceding chapters are especially im- 0% 20% 40% 60% portant for highly populated regions that can benefit the most from opening of markets and higher competitive- Source: World Bank staff based on HIES 2012/13. 92 | V. Social Inclusion for Shared Prosperity and Poverty Reduction Figure 5.3 Poverty headcount rate in Sri Lanka Conflict Affected Areas 217. Poverty rates are highest in portions of the Northern and Eastern provinces, which were at the center of the conflict. As pointed out above, the highest poverty headcount ratios at the dis- trict level are found in Mannar, Mullaitivu, and Kilinochchi at both the national pov- erty line and international poverty lines of $1.25 a day and $2.50 a day (Table 5.1). 218. In these districts, poverty rates are highest for the youth and those with no education. About 47 percent of people living in poverty in the Eastern and Northern provinces are younger than 25 – 50 percent if the more affluent districts of Jaffna and Vavuniya are excluded – as compared to only 40 percent in the other provinces. In particular, in Mannar, Mullai- tivu, and Kilinochchi, poverty rates among the youth are especially high, reaching 28 percent for 6 to 14 year olds and 22 percent for 15 to 24 year olds.81 These high mone- tary poverty rates are correlated with mul- tidimensional measures of welfare to the extent that poverty rates are disproportion- ately high among those with no education. Interestingly, poverty rates are twice as high for those with secondary than primary ed- ucation, suggesting that even reasonably Source:World Bank & DCS Poverty Map. Poverty line is Sri Lankan national poverty line. well-educated workers suffer from a lack of job opportunities in these districts. Table 5.1 Poverty in post-conflict areas is high 219. High poverty headcount rates in these regions National $1.25 $2.50 are associated with weak links to the labor market. This poverty line a-day a-day is reflected in low labor force participation rates. Across provinces, labor force participation rates are the lowest Districts outside of 6.1 2.8 29.9 for the Northern and Eastern provinces (Figure 5.4A), but Northern and Eastern in the absence of panel data that follows individuals over Provinces time it is difficult to see whether this is improving. When Eastern Province 11.0 5.5 47.3 looking at the country by sub population groups, the Northern province stands out for its low labor force par- Northern Province 10.9 6.1 45.5 ticipation among males, adults, urban residents, rural res- Jaffna 8.3 4.7 42.6 idents, and those with below O-level education. Similarly, the Eastern province stands out as having the lowest labor Vavuniya 3.4 1.6 23.1 force participation among youth and females. Mannar 20.1 12.4 60.9 220. In addition to low participation, the North and Mullaitivu 28.8 17.3 74.4 East also have high unemployment rates, particularly Kilinochchi 12.7 5.9 57.2 among the youth and among educated women. Youth Sri Lanka 6.7 3.2 32.1 Source: World Bank (2015) using HIES 2012/13. 81  World Bank, 2015 (Poverty Assessment, forthcoming) Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 93 Figure 5.4 The North and East have weak links to the labor market A. Primary activity by region B. Likelihood of unemployment relative to Colombo* (percent of working age population, age 15+) 150% Men 100 90 100% Women 80 42 38 43 50 46 49 53 46 47 70 55 50% 60 0% 50 40 -50% 30 56 61 55 48 51 49 45 52 50 20 42 -100% 10 Kandy Matara Hambantota Jaffna Killinochchi Mannar Vavuniya Mulativu Batticaloa Ampara Trincomalee Kurunegala Puttalam Polonnaruwa Badulla Moneragala Ratnapura 0 Sa va tal No rn n So al No n a ern -ce e rag te r U r r -w s te he To nt rth rth s rth ba Ce ut Ea We No South Northern Eastern N. Uva Employed Unemployed Out of LF West Source: Arunatilake et al (2015) using 2012 Labor Force Survey; includes all districts. * Results from a Probit regression estimating the likelihood of being unemployed. The model controls for age, education, marital status, ethnicity, the number of children and the elderly. For women it controls for whether she has children and whether there are other adult women in the household Box 5.1 Female-Headed households in the northern and eastern provinces Female heads of household are particularly vulnerable in the post-conflict setting of the Northern and Eastern Provinces. Female-heads of household in the Northern and Eastern Most of these household are headed by widows (see figure). Province by marital status However female-headed households are quite heterogeneous. First, childcare requirements may prohibit younger widows with small children from generating income, while older 100 female heads of households are less able to do certain types of 13.6 9.1 18.4 manual work. Second, widows whose husbands served in the 80 national army receive their husbands’ pension or 50 percent of his salary, while widows of men fighting in the LTTE receive a 60 51.6 55.2 one-time payment only if they can produce a death certificate. 62.4 Third, the application of family law according to different 40 communities’ legal codes can create varying outcomes. Sinhalese female heads may enjoy the benefits of a more 20 33.4 32.2 women-friendly Sinhalese legal code, while Muslim female 14.1 heads may face restrictions on their activities and become 5.1 1.4 3.6 0 particularly vulnerable when these prevent them from seizing Northern Eastern Sri Lanka income-earning opportunities. Finally, the loss of assets during Province Province the civil war can make it difficult to marry daughters as land and Never married Married house assets are commonly used as dowry. This is particularly important in Tamil communities. Widowed Divorced/Separated Source: Schmidt and Canpolat (2015) based on Vasudevan (2013), Source: Own calculations using HIES 2012/13 Jayatilaka and Amirthalingam (2015), and Ruwanpura and Humphries (2004). 94 | V. Social Inclusion for Shared Prosperity and Poverty Reduction Box 5.2 Inclusion of ex-combatants Persons with physical disabilities and psychological problems due to conflict, in particular ex-combatants, are particularly vulnerable to exclusion. An estimated 10 to 15 percent of the population in the Northern Province – a large portion of them ex-combatants -- suffers from a physical disability related to the conflict, In addition, epidemiological studies conducted among conflict-affected populations in Northern Sri Lanka show that the conflict has led to increased psychosocial problems among these populations. Although mental health issues are prevalent among ex-combatants, there is a lack of psychological assistance programs specifically designed for ex-combatants. Notwithstanding government programs to integrate former combatants, they still struggle to enter into the labor market and have relatively high levels of unemployment and underemployment. Social stigma -- fears of being associated with ex-combatants or perceptions that they are still violent -- contributes to their marginalization. In a qualitative study conducted with young female ex-LTTE fighters in the Eastern district of Batticaloa, Krishnan (2011) notes that job opportunities are more restrictive for female ex-combatants than their male counterparts, with the biggest barrier being that they are not able to use the clerical, engineering, or other non-combat skills they had learned. Ex-combatants face surveillance, which prompts fears that they have not been fully rehabilitated. Source: Schmidt and Canpolat (2015) based on Perera (2011, 2014), Siriwardhana and Wickramage (2014), Immigration and Refugee Board of Canada (2015), and Krishnan (2011). unemployment rates82 in the North and East were as high The Estate Sector83 as 27 percent in Ampara and 25 percent in Kilinochchi compared to 12.5 percent in Colombo in 2012. Moreover, 221. In addition to the populations in the North and the percentage of those looking for a job for more than a East, estate workers have long had high poverty rates. year was highest (65 percent) in the Eastern province. Over Because the majority of them descended from indentured 90 percent of the unemployed in the Northern and East- labor brought from India in the early 1900s and began to ern provinces were first-time job seekers, compared to 57 receive citizenship only in the 1980s, they lived for decades percent in the Western Province. Much of the reason for without state provision of social services. Large inequali- high unemployment in these two provinces is explained ties continue to exist in their access to, and utilization of, by high female unemployment, particularly among those health services. Estate workers are largely dependent on with A-level education or more. However, the probabil- the estate’s management for their basic needs, particularly ity of being unemployed is significantly higher for wom- housing.84 Since nationalization in 1975, the state has re- en in the North and East relative to Colombo, even after tained responsibility for providing education in the estate controlling for educational and other individual charac- sector. In 1994, the Ministry of Health was requested to teristics (Figure 5.4B). For men, no significant difference take over estate hospitals and had successfully taken over in the likelihood of unemployment is detected. The most hospitals and maternity wards and dispensaries by 2000.85 common search method in the North and East is to regis- Housing and land on the estates are under the control of ter for a government job (48 and 45 percent, respectively), plantation management. compared to Colombo where advertisements and infor- mal family networks are more common. This difference is 222. Poverty in the estate sector fell markedly in the especially large among well-educated workers. Together, past decade. Although the estate sector has traditionally this evidence points to very high aspirations in the North been the poorest in Sri Lanka, poverty rates typically have and East to be employed in the public sector. However, been only moderately higher in the estate sector than the in the absence of panel data that follows individuals over time it is difficult to see whether aspirations are changing. To the extent that these unmet aspirations are persistent, they could lead to further discontent. It is also important 83  The estate sector consists of state-owned plantations which com- prise over 170,000 ha, most of which is devoted to tea and rubber cul- to note that female-headed households and ex-combat- tivation. The plantations were originally set up by British colonists who ants are particularly vulnerable in a post-conflict setting brought in Indian origin Tamils as laborers. Housing and land on the (Boxes 5.1 and 5.2). estates remains under the control of plantation management while the state took over provision of social services and public infrastructure in the mid-2000s. The particular social and economic features of the estates have led to it being treated as a separate category from the rural and urban sectors. 84  Jayawardena, 2013. 82  Defined as the share of unemployed individuals ages 15-24. 85  Gunetilleke et al. 2008 Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 95 Figure 5.5 Most of the reduction in estate poverty happened Figure 5.6 Higher tea prices led to larger profit to the tea during 2006-2009 industry 400 1.6 35 30 317 313 27.7 290 30 270 274 267 300 267 271 1.4 25 242 Poverty rate ( percent) Exports (million kg) Price/Cost ratio 24.7 1.15 1.34 1.18 20 200 1.2 1.10 15 13.8 11.5 10.9 1.06 1.18 1.15 1.02 1.00 10 100 1.0 8.7 6.8 5 7.9 6.2 4.4 1.8 0 0 0.8 2002 2006/07 2009/10 2012/13 11 04 05 06 08 09 10 12 07 20 20 20 20 20 20 20 20 20 Urban Rural Estate Total tea exports Price/Cost ratio Source: World Bank (2015). Source: World Bank (2015). rural sector. In 2002, headcount poverty was estimated The large reduction in estate poverty is corroborated by to be 30 percent in the estate sector, as compared to 25 other welfare indicators, such as the multidimensional percent in rural areas (Figure 5.5). A gap between the rural welfare index reported by United Nations Development and estate sectors emerged in 2006/07, after poverty fell Programme (2012), which show a decline in multidimen- rapidly in rural areas but changed little in the estate sector. sional poverty from 21.1 percent to 11.4 percent between By 2009/10, however, the estate sector had largely caught 2006 and 2009. up to the rural sector, and by 2012/13 the estimated head- count poverty rate in the estate sector was 10.9 percent, 223. One potential explanation for this sharp decline compared with 6.8 and 1.8 percent in rural and urban ar- in estate sector poverty is the substantial increase in eas, respectively (Figure 5.5). In fact, most of the decrease the price of tea, which is the major output of the estate in estate poverty during the period of 2002-2012/13 oc- sector as well as Sri Lanka’s largest exported commodity curred between 2006 and 2009 (from 28 to 11 percent). by export value. The Colombo auction price for tea surged Figure 5.7 Real wage increases have been largest in the estate sector A. Growth in monthly average real wages B. Wage premiums relative to urban sector 10 9.2 1 Estate Rural Urban Rural Estate 8 0.8 6 4 2.9 2.8 0.6 2 0.4 0 0.2 -2 -1.7 -4 0 2002-2012 2002-2006 2006-2009 2009-2012 2006 2007 2008 2009 2010 2011 2012 Source: Arunatilake et al (2015) using LFS data. Note: Calculations exclude Northern and Eastern provinces. CCPI (2002=100) and CCPI (2006/7=100) are used to convert nominal wage to real wages. 96 | V. Social Inclusion for Shared Prosperity and Poverty Reduction Figure 5.8 Poverty headcount and poverty gap by location, 2012 /2013 A. National poverty line B. $2.50 poverty line 12 Poverty headcount 10.9 60 Poverty headcount 50.6 Poverty gap Poverty gap 10 50 7.6 8 6.7 40 34.3 32.1 6 30 17.7 4 20 13.4 2.1 8.9 1.4 1.6 8.2 2 1.2 10 0.3 3.8 0 0 overall urban rural estate overall urban rural estate World Bank (2015) using all districts in HIES 2012/13. while the quantity of total tea exports remained stable. Figure 5.9 Nutrition indicators This resulted in much higher profit margins and revenue for the tea industry, as reflected by higher ratio of auction price and production cost (Figure 5.6), along with higher 45% wages for estate workers. 40% 35% 224. In fact, wage increases were larger in the estate 30% sector when compared to the agricultural sector as a 25% whole (Figure 5.7A). This may be partly because estate 20% workers had negotiated minimum wage increases be- 15% tween 2009 and 2010. When controlling for individual char- 10% 5% acteristics, the premium for being an estate-sector worker 0% relative to an urban worker has significantly increased over Stunting in Low Birth Underweight time (Figure 5.7B). Although real wages in the rural sector children up to Weight women ages have been statistically the same as what an observational- age 5 15-49 ly equivalent worker would earn in the urban sector, they were significantly higher than real earnings in the estate National Estates Rural Urban sectors in 2009 and 2010. This highlights a large increase in profitability during that time period for own-account Source: DHS, 2007. farmers compared to estate worker earnings, despite the the $2.50 poverty line, the poverty headcount is 50.6 per- increase in minimum wages. However, rural-sector worker cent in the estates compared to 34.3 percent in rural and premiums have since fallen, in line with commodity prices. 17.7 percent in urban areas. In fact, about 40 percent of 225. Despite recent improvements, poverty rates the population in the estate sector still lives between the continue to be higher in the estates when compared to national poverty line and $2.50 a day (2005 PPP). This indi- both urban and rural sec- cates that a large share of the estate sector population is nearly poor and is vulnerable to adverse shocks. Moreover, A large share of tors, pointing to continued vulnerability. As shown in the poverty gap index, measuring how far people are from the estate sector Chapter II, the poverty head- the poverty line, is also considerably higher in the estates, at 13.4 percent compared to 8.9 percent in rural areas at population is nearly count is 10.9 percent in the the $2.50 poverty line (Figure 5.8). Moreover, 62.7 percent estates, compared to 7.6 per- poor and vulnerable cent in the rural sector and of the population in the estate sector is in the bottom 40 to adverse shocks 2.1 percent in the urban sec- percent of the distribution, compared to 42.5 percent for rural and 23.3 percent for urban populations. tor poverty (Figure 5.8). At Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 97 226. Non-monetary indicators of poverty, health and Figure 5.10 Housing conditions in estate sector (percentage nutrition are worrisome, especially in the estates. Is- of households with access) land-wide 21 percent of children under 5 are underweight, 16 percent of babies born have low birth weight and 16 percent of women of reproductive age (15-49) are mal- 98 92 90 89 nourished. Estates have the highest maternal mortality 100 79 83 77 rates in the country, and both estate women and children 80 68 69 suffer from severe malnutrition. About 30 percent of chil- dren below 5 are underweight, nearly one in three babies 60 47 43 born have low birth weight, and one-third of women of re- 31 40 productive age are malnourished (Figure 5.9). A significant 20 reason for child and maternal malnutrition in the estate sector was intake of the “wrong” kind of foods, specifical- 0 ly those lacking in protein.86 The fact that estate women Drinking water Toilet available Access to traditionally eat whatever remains after men and children inside premises within the unit electricity have been fed is considered a contributing factor to wom- en’s malnourishment.87 Being undernourished and over- Overall Urban Rural Estate worked, mothers in the estates give birth to weak children and have inadequate breast milk, both of which contribute Source: World Bank (2015), all districts in HIES 2012/13. to high levels of infant mortality. 227. Housing provided for the estate workers is of- Figure 5.11 Access to health and education services ten described as inadequate. Estate-sector households (average time to travel, in minutes) are less likely to have drinking water, sanitary facilities or electricity within their households. The differences are par- ticularly large for availability of drinking water; only 68.1 60 percent of households in the estates have drinking water 49 available inside their premises, compared to 77.3 percent 50 of households in rural areas (Figure 5.10). Similarly, less 34 35 40 32 than one-third of estate households have a toilet available 23 30 21 22 in their unit, compared to 43.2 percent of households in 18 16 rural areas. Philips (2005) argues that the lack of toilets and 20 11 11 8 running water implies that mothers and daughters need 10 to wake up early in the morning and go to bushes for bath- 0 ing and other needs, exposing them to all kinds of threats. Nearest bus stop Secondary Nearest hospital Often, entire families live in so-called line rooms – bar- education rack- type single rooms that are roughly 12 by 10 feet and described as crowded, damp, smoky and dark with leak- Overall Urban Rural Estate ing roofs and inadequate light and ventilation.88 Housing, education, health care and childcare are often provided as Source: World Bank (2015), all districts in HIES 2012/13. non-monetary “welfare packages” to estate workers. It is argued these create a total dependency of workers on the management for all aspects of their lives.89 to travel longer to reach a bus stop, secondary education 228. Moreover, access to services and the quality of and the nearest hospital (Figure 5.11). Most schools in the services in the estates is comparatively low. Travel times estates are primary schools and upon completion of pri- generally mean that estate workers are isolated in terms mary education, students have to travel to nearby villag- of access to health and education. Estate workers need es to continue with secondary education. Poor roads and lack of transport facilities may contribute to the low en- rollment rates at the secondary schools among the estate population.90 Health facilities in the estates do not meet 86  Jayawardena, 2014. 87  Aheeyar 2011, Philips 2005 88  Little 1999; Aheeyar 2011:10 89  Gunetilleke et al. 2008:53 90  UNFPA 2014: 24; Aheeyar 2011:11 98 | V. Social Inclusion for Shared Prosperity and Poverty Reduction Figure 5.12 Educational levels and enrollment A Level of education completed for individuals B. Share of individuals in respective age group enrolled in age 20 and above education (percentage of age groups) 98 98 99 96 99 98 99 96 Estate 100 90 Rural 2012*** 80 72 66 66 Urban 70 Sri Lanka 60 49 50 Estate 40 Rural 30 2003** Urban 20 Sri Lanka 10 0 Age 0 5 10 15 20 25 30 35 40 45 50 55 60 5-9 10 - 14 15 - 20 Degree & higher G.C.E (A/L) Less than Primary Overall Urban Rural Estate G.C.E (O/L) Primary Source: Arunatilake et al (2015) using Labor Force Survey Note: *** All districts, ** excludes Northern Province national standards; hospitals in the estate sector are less ka as a whole, with the corresponding improvement in the well equipped and there are fewer trained health staff and estate sector from 53 percent to 63 percent. The propor- medicine.91 Poor quality of health services pushes estate tion of those who have completed O-levels improved from workers to obtain private health services at higher prices.92 7 percent to 9 percent in the estate sector. However, the Estate hospitals were taken over by the government in proportion of the estate-sector working-age population 2007, but it has been difficult to send doctors to staff those with at least A-levels remains low at 3 percent, although hospitals due to their remote locations. Estate schools improved from 1 percent in 2003. The estates not only are also run by the public sector, and, again, allocation have low levels of education for adults relative to the rest of teachers (especially Tamil-speaking teachers) has been of the country (Figure 5.12A), but more importantly, they difficult. Successive governments have changed teacher have lower enrollment rates, particularly among 15 to 20 recruitment policies (including school-based recruitments year olds, of which only 49 percent are enrolled compared rather than national level recruitments) to improve the sit- to 66 percent in rural areas (Figure 5.12B). uation. 230. The youth are in- 229. Poor outcomes in education impede the ability creasing leaving the estate The number of youth sector. Between 2003 and 2012, the share of popula- ages 15 to 24 in the of the estate population to participate in Sri Lankan society. Across sectors, the greatest improvement in ed- ucation attainment is seen in the estate sector, but it still tion in the estate sector in- estate sector has remains low compared to other sectors.93 For instance, the creased from about 660,000 declined while the to about 682,000, an aver- age growth of 0.4 percent a share of adults aged proportion of those who have completed primary level ed- ucation improved from 82 percent to 86 percent in Sri Lan- year, compared to an aver- 60 and above has per year for the country as a increased age growth of 1.3 percent 91  Ahmed 2014; Gunetilleke et al. 2008 whole. However, the number 92  Gunetilleke et al. 2008 of youth ages 15 to 24 actually declined (Figure 5.12B), par- 93  In this paragraph, 2003 does not include the Northern Province, ticularly among those aged 15-20. In contrast, the share of while 2012 includes the Northern Province. adults aged 60 and above increased by 8 percent a year Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 99 Figure 5.13 The youth are leaving the estate sector and the share of agricultural workers is in decline A. Change in Population Structure B. Composition of workers in the estate sector by type (average annual change percent, 2003-2012) (number of workers, share of total) Estate Rural Urban 10% 400,000 number of workers 300,000 5% 200,000 0% 100,000 0 -5% 2006 2007 2008 2009 2010 2011 2012 age group Non agricultural Ag. self-employed Ag. wage workers Ag. unpaid family & other ve tal -19 -24 -29 -39 -49 -59 bo To &a 15 20 25 30 40 50 60 Source: Arunatilake et al (2015) using Labor Force Survey data. Data exclude Northern province for comparability on average. This shift in the population structure also coin- Figure 5.14 Labor force participation and unemployment cided with a movement away from agriculture wage work rates for youth, ages 15-24 among those who live in the estates, while the share of workers engaged in non-agricultural activities – primarily 80% 69% manufacturing, transport, commerce and community ser- 66% vices – increased from 24 to 30 percent between 2006 and 60% 57% 56% 2010, but then declined somewhat in 2012 (Figure 5.13). 60% 41% 231. The educated estate youth face difficulties in 40% accessing salaried employment outside the estate sector. While opportunities for estate youth to work in 12% 20% 11% 9% service-sector industries, such as retail stores and com- 4% 6% 6% munication centers, are expanding in nearby villages, the opportunities to work in professional, salaried occupations 0% are not easily available to the estate youth. Despite their Urban Rural Estate preference to work in such occupations, estate youth has to compete with better educated and socialized peers Unemployed 2003 Unemployed 2012 from the rural and urban sectors who are preferred by em- Out of labor force 2003 Out of labor force 2012 ployers.94 Due to this situation many estate youth take on lower-level job openings, such as domestic workers, shop Source: Arunatilake et al (2015) using LFS. Data exclude Northern province for assistants or construction workers, and relatively few are comparability. able to secure jobs as semi-skilled workers, such as drivers or mechanics. According to a qualitative study conduct- the share of estate youth who are out of the labor force ed by Gunetilleke et al. (2008), most of the estate youth has increased by over 40 percent, compared to an 18 per- reported facing stigmatization and discrimination due cent growth in rural areas. Although this may be correlated to their Indian Tamil ethnicity and estate worker identity, with a higher share of youth being enrolled in school, it both of which constitute a barrier in accessing non-estate also suggests “voluntary” inactivity due to the mismatch of job opportunities. While youth unemployment is low and job opportunities and aspirations. declining relative to the rest of the country (Figure 5.14), 232. Women in the estates face additional layers of exclusion. Women tend to be employed for the low- est-paying unskilled tasks that require intense labor such 94  Gunetilleke et al. 2008 100 | V. Social Inclusion for Shared Prosperity and Poverty Reduction Box 5.3 Gender-based violence: one of the most extreme forms of exclusion GBV is one of the most extreme interferences with women’s dignity, and it impacts their opportunities to participate in society. The forms of violence faced by the women in Sri Lanka range from rape and domestic violence to sexual harassment in public transportation. All these prevent women’s access to health, education and employment opportunities. Legal consequences for rapists are rare and, in a UN-led survey, only 34 percent of those who admitted rape felt worried or guilty about their actions, suggesting that social norms are permissive of this extreme form of violence against women. Several studies argue that violence against women has increased due to conflict and disaster. The presence of military forces, the setting of displacement camps, the loss of male household members to war and alcohol abuse caused by war-related trauma increase insecurity for women. The tsunami additionally contributed to this environment of insecurity for women, who became victims of sexual and domestic violence both in the immediate aftermath of the disaster and during the post-tsunami rehabilitation and reconstruction process. Finally, due to instability caused by the conflict and natural disaster, girls were rushed into child marriages to tsunami widowers who sought government subsidies for marrying and starting a family, creating vulnerability. Gender-based violence is linked to cultural norms and attitudes about masculinity. In a survey conducted in Colombo, Hambantota, Nuwara Eliya and Batticaloa districts, de Mel et al (2013) argue that male perpetration of gender-based violence is linked to cultural attitudes about how to be a man. The study found that majority of men as well as women linked manhood to dominance, toughness and violence. Men who reported committing sexual violence often were motivated by sexual entitlement – as men they perceive themselves as having right to have sexual relations with women. Fifty five percent of men in the sample agreed that in case of rape one would have to question whether the victim is promiscuous or has a bad reputation. Regarding intimate partner violence (IPV), 41 percent of male respondents agreed with the statement that a woman should tolerate violence in order to keep the family together. Around 78 percent of men affirmed the view that women should obey their husbands, while 58 percent of men stated that women could not refuse their husbands. Women also contribute to the persistence of inequitable gender norms: 58 percent of women (a higher percentage than men) believed that a woman should tolerate IPV in order to keep the family together. Moreover, 75 percent of women agreed that, “some women ask to be raped by the way they dress and behave.”. According to the study, male attitudes on reproductive issues, equal wages, children’s education, women associations and entry into politics were more equitable. Seventy percent of men agreed that women should be in public decision-making roles and 62 percent supported the greater participation of women at the elections. Lastly, the study emphasized particular vulnerabilities that men face throughout their lives, which increases their risk of perpetration of violence against women. Economic pressures resulting from inadequate income, lack of economic assets, and financial responsibilities as breadwinners are found to be among the primary causes of male stress and lack of well-being. Male respondents are also found to have moderate level of depression and suicidal thoughts. Source: Schmidt and Canpolat (2015) based on Hettige et al. (2012), Save the Children (2006), Fisher (2010); Immigration and Refugee Board of Canada (2012); Perera et al. (2011), Solotaroff and Pande (2014), Rush (201), UNHCR (2004); Freedom House (2011); Biermann (2006); and de Mel et al (2013) as tea plucking or rubber tapping.95 According to Kotikula tate workers by male supervisors in the fields. According to and Solotaroff (2006), approximately 86 percent of female a qualitative study commissioned by United Nations Pop- estate workers are fieldworkers and estate women face ob- ulation Fund (UNFPA) in 2003 with 350 women in estates stacles in moving up to higher-level positions. Gender seg- in Hatton, 83 percent of women were found to be victims regation varies by the type of estate management as well of GBV (Box 5.3).97 as the type of crop; it is found to be less severe in rubber estates, where 25 percent of supervisors are women, com- 233. More generally, alcoholism is found to be an is- pared to 5 percent in tea estates. Despite being income sue in the estates.98 Poor housing and infrastructure are earners, there is substantial anecdotal evidence that es- seen as one of the reasons behind high levels of alcoholism tate women’s wages are often collected by their husbands in the estates. In the qualitative study conducted by the or fathers who, in turn, often spend it on alcohol.96 Their Center for Poverty Analysis in 2005 with the estate pop- status in the estates makes women vulnerable to gen- ulation, alcoholism was identified as a major community der-based violence (GBV), and not only at home; there are problem, especially by female and young respondents, also frequent reports of harassment, rape and abuse of es- and it was perceived as a primary cause of poverty. Accord- ing to a baseline survey conducted in 2005 in the estates, 95  Kotikula and Solotaroff 2006; Philips 2005; Jayawardena 1984 97  Perera et al. 2011 96  Aheeyar 2011; Ahmed 2014; Daniel 1993; Jayawardena 1984 98  Gunetilleke et al. 2008; World Bank 2007; Aheeyar 2011 Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 101 Figure 5.15 Moneragala labor force characteristics and travel times to facilities A. Type of work B. Travel time to facilities (share of total employed, ages 15+, 2012) (average time in minutes, 2012/2013) Percent of total employed 40 50 35 45 30 25 40 20 35 15 10 30 Minutes 5 25 0 Agricultural self- 20 Nonagricultural self- Agricultural Public Private formal Priavte informal employed employed Formal-employer Informal-employer Unpaid Family worker 15 10 5 0 Clinic Dispensary Hospital Maternity clinic Agricultural center Educational facility Wage worker Self Employer Employed National Average Moneragala National average Moneragala Source: Arunatilake et al (2015) using LFS 2012. Source: World Bank (2015), all districts HIES 2012/13. the number of working men who regularly consume alco- lenges, including loss of jobs and social support mecha- hol was found to range between 50 to 75 percent.99 The nisms, for the estate population. same survey also revealed that 25 to 50 percent of daily earnings were spent on alcohol. Alcoholism in estates has Moneragala number of effects, including draining household income and diverting funds from basic needs. Alcoholism is also 235. Persistent high poverty rates in Moneragala are associated with abuse of, and violence against, women in related to its strong reliance on agriculture and rela- the estates.100 tively little diversification within households to other industries. Moneragala is the second largest of the 25 dis- 234. Over the longer term, RPCs face major challeng- tricts in Sri Lanka, with relatively low population density es which, given their extensive role in providing ser- (82 per square kilometer compared to an average of 331 vices, may impact the estate population. RPCs histor- for the country as a whole in 2014101). Moneragala is home ically provided social support “from womb to tomb” and continue to provide some services as well as guaranteed to tea, rubber and coconut plantations and a large number lifetime employment. While the youth seek to leave the of small holders, with 34 percent of households cultivat- estates in general, there is still a large population, includ- ing paddy land compared to 18 percent for the country ing a significant number of elderly dependents. The RPCs’ as a whole. As such, it is mostly an agricultural district; 57 business model is under pressure from a combination of percent of the workforce engaged in agricultural activities, factors: declining profitability due to relatively higher compared to 31 percent for the country as a whole, while wages after several increases over the past decade while only 32 percent of workers are in services compared to 43 facing stiff competition from more productive growers in percent for the country as a whole (LFS, 2012). Moreover, Kenya and India; declining prices for estate commodities it has a relatively high share of self-employed agricultural (tea, coconut products, and rubber); and reduced demand workers and unpaid family workers, and relatively fewer from key historical consumers in Russia and the Middle non-farm or wage employees. The relatively low density of East. There are estimates that up to half of tea plantations’ the population coupled with the high reliance on agricul- acreage requires replanting. The difficult prospects for the ture suggests that households in Moneragala are less di- sector may translate into profound socio-economic chal- versified, and as such, are especially vulnerable to agricul- tural price fluctuations and have few alternative sources of income (Figure 5.15A). 99  Aheeyar 2011 100  Gunetilleke et al. 2008; Jayawardena 1984 101  DCS, Mid-year population estimates, 2012-2014. 102 | V. Social Inclusion for Shared Prosperity and Poverty Reduction Figure 5.16 Sri Lankan Tamils and Moors have higher levels of poverty A. National poverty line B. US $2.50-a-day poverty line (percent of population) (percent of population) 14 50 44.4 46.3 12.0 12 45 37.2 9.4 40 32.1 10 Percent of Households Percent of Households 35 28.8 8 6.7 30 5.9 6.0 25 6 20 13.2 3.1 12.8 12.1 4 2.4 15 8.2 7.2 8.9 1.2 1.0 1.5 1.0 10 3.5 2 0.4 5 0 0 overall Sinhala Sri Lankan Indian Sri Lankan Other overall Sinhala Sri Lankan Indian Sri Lankan Other Tamil Tamil Moor Tamil Tamil Moor Poverty headcount Poverty gap Poverty headcount Poverty gap Source: Arunatilake et al (2015) using LFS 2012. Source: World Bank (2015), all districts in HIES 2012/13. 236. Persistent high poverty rates in Moneragala are poverty line, the poverty headcount for Indian Tamils is also related to relatively low access to services. Average 46.3 and for Sri Lankan Tamils is 44.4 percent, compared to levels of education are below the national average, with an overall poverty headcount of 32.1 percent. Using both about eight years of education compared to the national poverty lines, the poverty gap for the Sri Lankan and Indi- average of nine. Access to services is in line with the na- an Tamils is above the average (Figure 5.16). tional average, with the exception of electricity and san- itation, which are well below the country average. Travel 238. Empirical analysis finds that most of the diffe- times to secondary schools, hospitals and agricultural cen- rences in monetary poverty is related to inequality of ters are also higher than for the rest of the country (Figure opportunities. The likelihood of being poor is not stati- 5.15B). Approximately one-third of total area in the district stically different for ethnic minorites relative to the Sin- is covered by natural forests under natural parks and/or hala majority if one controls for education, ownership of sanctuaries that are not available for human development. assets,and access to services.103 Estimates from a multivari- However, there is increasing encroachment of forests, a ate profile of risk-of-poverty growing human-wildlife conflict, and soil degradation show that the likelihood of Most of the being poor increases with the number of family mem- differences in from gem mining in its granite deposits.102 Further analysis on the determinants of poverty in Moneragala would be useful to design multi-sector interventions that could help bers, particularly children. monetary poverty to reduce the relatively high levels of poverty prevalent in With respect to the locati- on of the households, rural have to do with households have a higher inequality of the district. probability of being poor as opportunities B. Inclusion of Ethnic Communities holds, while there is a high particularly with opposed to urban house- 237. There are differences in poverty rates among Sri premium for living in the respect to education Lanka’s ethnic communities. Sri Lankan Tamils and Sri Western province. Any level and access to services Lankan Moors constitute the two largest ethnic minority of education attained after groups and have higher levels of poverty. Using the nation- compulsory education (ju- al poverty line, Indian Tamils and Sri Lankan Tamils have nior secondary, O-levels) decreases the chances of being poverty rates that are 3.3 and 5.3 percentage points higher poor. Meanwhile, living in a household where the head has than the Sinhala population, respectively. Using the $2.50 no education or just primary education is linked to higher 102 Attanpola et al. 103  World Bank Poverty Assessment, 2015. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 103 Figure 5.17 Access to services and educational attainment by ethnicity A. Access to basic services B. Educational attainment (percentage of households) (average years of education, ages 15+) 100 92 94 90 84 10.0 84 7982 76 74 80 72 68 9.0 63 62 63 58 60 48 8.0 42 47 40 3333 7.0 20 6.0 0 5.0 Drinking Pipe borne Toilet Access to 2002 2003 2004 2005 2006 2007 2008 2009 2010 2012 2011 water inside line (main available electricity premises line) near within the their house unit Sinhala Sri Lankan Tamil Overall Sinhala Sri Lankan Tamil Indian Tamil Sri Lankan Moor Indian Tamil Sri Lankan Moor Source: Arunatilake et al (2015) using LFS 2012. Source: World Bank (2015), all districts in HIES 2012/13. chances of being poor compared to households where the improved for all population groups, the average level of head has completed compulsory education. Ownership education for Tamils is lower than that of other ethnic of assets such as mobile phones, a sewing machine, or a groups, even when excluding the most war-affected re- television lowers the probability of being poor, as does ac- gions. For instance, comparable data over the last decade cess to services, particularly having running water within (excluding the North and Eastern Provinces) finds that 22 premises. Age, gender, and sector of activity of the house- percent of Sri Lankan Tamils had less than primary educa- hold head, once controlling for all other covariates, are not tion (compared to 12 percent for the Sinhalese workforce) statistically significant in assessing the risk of poverty of an and only 10 percent had completed A Levels, compared individual. Moreover, the probability of being poor is sta- to 13 percent for the Sinhalese workforce. This has meant tistically the same for Sri Lankan and Indian Tamils, once that, on average, the Sinhalese workforce has had consis- individual, household, and locational characteristics are tently higher levels of education when compared to the controlled for. This points to the fact that most of the diffe- Tamil or Moor workforce (Figure 5.17B). rences in monetary poverty have to do with inequality of opportunities, particularly with respect to education and 241. Rates of ownership of land are also uneven access to services. among the country’s ethnic communities. According to the 2012/13 HIES, 88.6 percent of Sinhalese households 239. Access to services is particularly low for Tamils. owned land, compared to 83.3 percent of Sri Lankan Moor For a range of indicators, the most recent household sur- households, 73.2 percent of Sri Lankan Tamil households, vey shows that Sri Lankan Tamil households have lower and 36.5 percent of Indian Tamil households (Figure 5.18). access to basic services, --including drinking water within The lower rates of ownership among Sri Lankan Tamils, their premises, the availability of a pipe borne line nearby may be due, in part, to difficulties in restoring ownership their house a toilet within their unit, or access to electricity rights following the destruction of property registries and (Figure 5.17A). Despite increased spending on infrastruc- loss of documentation owing to the conflict. The lower ture across the country, this evidence points to remaining rates of ownership among Indian Tamils reflect the contin- infrastructure needs, particularly related to improving ued provision of housing by many estates, although recent housing services. At the same time, Sri Lankan Moors, have years have seen cases where ownership of houses and as- higher access to basic services than the majority Sinhala sociated plots has been transferred. population. 242. Empirical analysis using labor force surveys 240. Educational attainment is lower for the ethnic finds no statistical differences in unemployment rates minority workforce. While educational attainment has across ethnic groups, while Sinhalese are more likely 104 | V. Social Inclusion for Shared Prosperity and Poverty Reduction Figure 5.18 Share of households owning some land, by Figure 5.19 Likelihood of activity relative to public sector ethnicity employment and Sinhalese counterpart (individuals age 15 and over) 100 84.4 88.6 83.3 77.2 2.0 73.2 Percent of households 80 1.5 1.0 60 0.5 36.5 40 0.0 -0.5 20 -1.0 -1.5 Male Female 0 -2.0 overall Sinhala Sri Indian Sri Other -2.5 Lankan Tamil Lankan Tamil Moor SL Moor SL Moor SL Moor SL Moor Indian Tamil Indian Tamil Indian Tamil Indian Tamil SL Tamil SL Tamil SL Tamil SL Tamil Source: World Bank (2015), all districts HIES 2012/13. Formal private Informal Non-wage Unemployed to be employed in the public sector. Labor force partic- private informal ipation is low and unemployment is high for Sri Lankan Tamils and Moors, relative to the Indian Tamil and Sinha- Source: World Bank (2015), all districts HIES 2012/13. lese populations. However, much of this has to do with individual characteristics and the locational concentration 243. The evidence suggests that non-Sinhalese men of these populations. When focusing outside of those re- are more likely to be associated with private infor- gions, both Sri Lankan and Indian Tamils have higher labor mal-sector jobs relative to their Sinhalese counter- force participation and employment rates relative to their parts. Even after controlling for individual characteris- Sinhalese counterparts. This tics, such as age, education, and marital status, as well as There are no suggests that different rates of participation are mostly household characteristics, such as the number of children statistical difference determined by differences in and the district in which they are located (Figure 5.19), eth- nic minorities seem to be more likely to work in informal in the likelihood of employment opportunities. jobs. Tamil men are generally more likely to work in pri- Moreover, quantitative anal- being employed ysis shows that there are no vate activities relative to their Sinhalese counterparts, and within the private sector, Sri Lankan Tamils are more likely across ethnic groups statistical differences in the to work in informal private wage work. In contrast, Indian once one controls for likelihood of being unem- ployed across ethnic groups, Tamil men are more likely to work in private wage work or age, education, and once you control for age, ed- to be unemployed than to work in the public sector com- pared to their Sinhalese counterparts. Finally, Sri Lankan other individual and ucation and other individual Moor men are more likely to be informal private-sector and household character- household statistics istics. The only exception is wage workers, informal self-employed workers, or to be that Indian Tamil males are unemployed than to work in the public sector relative to more likely to be unemployed relative to their Sinhalese their Sinhalese counterparts. Non-Sinhalese women, in counterparts, in line with higher male unemployment in contrast, are less likely to work as private self-employed the estate sector.104 In terms of the activity across popula- workers compared to their Sinhalese counterparts, while tion groups, empirical analysis using the labor force sur- Sri Lankan Moor women are more likely to work in the veys finds that Sinhalese workers are more likely to work public sector compared to their Sinhalese counterparts. in the public sector than other ethnic groups (Figure 5.19). For women, there seems to be a stronger likelihood of par- This empirical result cannot be corroborated against ad- ticipating in the public sector, particularly for Sri Lankan ministrative employment data because the ethnic make- Moors. However, this may be associated with their relative- up of the public service is not tracked. ly low participation in general (see below). 244. Beyond these quantitative measures, percep- tions of fairness, particularly when it comes to job op- 104  Arunatilake et al, 2015. portunities, can be an important aspect in assessing Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 105 Figure 5.20 Household debt to money lenders by province A. Share of households indebted to money lenders, percent B. Average amount of debt of households by region, Sri Lankan Rupees 18 18,000 15.5 16 16,000 14 14,000 12 9.9 12,000 10 8.2 10,000 7.1 7.1 8 6.1 6.2 8,000 5.1 5.6 4.9 6 6,000 4 4,000 2 2,000 0 0 rag Uva am a No n W n ral So al en en We ll rn Ce n No rn W n So ral rth ern We ll a a rag Uv rth rn r rth ter ral era r rth ter era r uw uw he ste ste he nt nt rth rth nt No este No est nt No Eas No as ut Ce Ov Ce am ut Ov Ce E ba ba Sa Sa Source: World Bank (2015), all districts in HIES 2012/13. the success of efforts towards social inclusion. A per- have received lower levels of assistance. Their protracted ception survey carried out by the Asia Foundation (2011) displacement is sometimes hidden due to factors includ- suggests that, compared to Buddhists, Hindus and Mus- ing deregistration of IDPs based on whether one’s family lims are less optimistic about improvements in minority place of origin is open for return, but they still live in dis- rights and equal treatment in the government job market. placement. Religious minorities were also less likely to think that the country is moving in the right direction. 246. Families returning to their place of origin in the North are faced with problems of indebtedness. Ac- cording to a mixed-methods study, which compares the Internally Displaced Persons and Returnees: An amount of debt between groups who differ only in wheth- Additional Axis of Exclusion er they engage in housing construction, households that engage in housing construction have significantly high- 245. An additional dimension of exclusion across er debt despite the housing assistance they received.106 ethnic lines concerns internally displaced persons. About 73 percent of housing beneficiaries in the sample The post-war period has seen the return of over 700,000 reported borrowing money on top of the housing assis- displaced persons to their place of origin in the Northern tance provided to them. Reasons for doing so included and Eastern Provinces. Although basic material needs have the desire to build larger and better houses. As most of largely been met,105 returnees nonetheless face multiple the returnee families engage in casual labor and lack suffi- challenges in accessing shelter, food and infrastructure cient and stable income to repay their loans, they become and developing livelihoods. There are particular difficul- indebted. In addition, Romeshun et al. (2014) argue that ties in securing land rights owing to the lack of an effec- most of the households lack financial literacy, such as tive claims dispute mechanism and the loss of documen- knowledge about interest rates, and they have poor man- tation owing to conflict and displacement. At the same agement of grant money, which worsens their debt situ- time, there is migration into the North and East of other ation. Female-headed households and households with ethnic groups -- particularly Sinhala, some of whom were disabled members are found to be particularly vulnerable. displaced decades earlier – which creates tension over ac- Anecdotal evidence suggests that there are cases of sui- cess to land. Finally, there are also a number of long-time cides and attempted suicides linked to indebtedness.107 IDPs, comprised mainly of Sri Lankan Tamils and Moors, The high share of households indebted to money lenders who are excluded from the official statistics on IDPs and and the average amount owed by households to money 105  UNOPS and Government of Sri Lanka. Joint Needs Assessment, 106  Romeshun et al. 2014 2015 107  Kadirgamar 2014; Romeshun et al. 2014 106 | V. Social Inclusion for Shared Prosperity and Poverty Reduction lenders in the Northern and Eastern Provinces (Figure 5.20) slightly declining over the last decade. Across age groups, indicates both the comparatively high levels of indebted- the drop in labor force participation rates was highest for ness as well the resort to this less institutionalized form of the youth (Figure 5.21B). To a large extent, this is due to money lending in these provinces. While high rates of in- more young women continuing their education. In fact debtedness in the North and East do not only affect IDPs, this is the main reason for non-participation among young their particular circumstances appear to be the main driver women in 63 percent of cases in the 2012 labor force sur- of the problem. vey, up from 57.6 percent in 2002. In contrast, labor force participation for 60 to 69 year olds has increased over time. 247. Local empowerment in areas with concentrations of minorities remains an issue. Some empowerment 249. Female labor force participation rates are higher has occurred, notably through the holding of elections to for those with either low or high levels of education. provincial councils and, more recently, the return of some Women with A-levels had participation rates that were 17 lands occupied by the military and the appointment of a percentage points higher than those with O-levels (the civilian governor to the Northern Province. While there are next highest level of education) in 2012, and those with a reports of easing, the high number of security forces in the degree or more had a participation rate 36 points higher conflict-affected areas has been cited as one of the main than those with A-levels (Figure 5.21C). However, the dif- obstacles for IDP returnees and others in rebuilding their ference in participation rates between highly educated livelihoods and achieving durable solutions.108 Reported women and those with less education is narrowing, albeit continued surveillance and engagement by the military slowly. This is seen by the flattening of the curve in Fig- in local economic activities also have negatively affected ure 5.21C over time and holds true even when controlling IDP returnees and communities affected by the conflict.109 for other regional and individual characteristics. Between Settlement and implementation of a division of authority 2003 and 2012, the difference in the likelihood of partici- between national, provincial, and local governments, espe- pating declined by 8 and 7 percent for women with incom- cially in the North and East, remains an outstanding chal- plete primary and completed primary education, respec- lenge. In addition, ensuring that further reconstruction and tively, relative to those with university degrees or higher.110 development projects proceed in a participatory manner will be important for inclusion. 250. As in most countries, labor force participation is lower for married women and for those with children. Indeed, the labor force survey confirms that separated C. Gender Inclusion or divorced women have the highest rates of labor force participation, while participation for married and never Low Female Labor Force Participation married females is similar (Figure 5.21D). Married women were less likely to participate than similar single women, 248. Sri Lanka faces a low and slightly declining rate who in turn were less likely to participate than separated of female labor force participation. Sri Lanka’s female la- or divorced women once we control for age, education, re- bor participation had been stable at slightly below 40 per- gional and other individual and household characteristics, cent for the past few decades up until the 2000s, when it in line with previous analysis.111 Similarly, women with chil- started to decline. Although participation of women in the dren under 5 were less likely to participate. On the other labor force is higher in Sri Lanka than its South Asian com- hand, the presence of other adults in the household who parators, it is lower than comparable middle-income coun- presumably can take care of children is commonly found tries, despite decades of low to increase labor force participation by women. This sug- gests that better access to affordable quality childcare fa- Female labor force levels of fertility and good educational outcomes (Fig- cilities could stimulate female labor force participation.112 participation has ure 5.21A). In 2013, female Furthermore, marriage changes the definitions of what been static with a labor force participation stood at 35.6 percent, com- slight decline in the pared to a male participation 2000s rate of 74.9 percent. More- 110  Results from a Probit regression estimating the likelihood of wom- en participating in the labor force. The model controls for age, marital over, participation has been status, being household head, ethnicity, region and district fixed effects, whether she has children, and the number of adults age 80+. Estimates based on Labor Force Surveys excluding the Northern province for com- parability over time. See Arunatilake et al. (2015). 108  Internal Displacement Monitoring Centre 2012; Keerawella 2013; 111  Gunatilaka, 2013; Sinha, 2012 Raheem 2013; Saparamadu et al. 2014; Fonseka and Raheem 2010 112  Premaratne 2011, Madurawala 2009, Dias 1990, Jayaweera and 109  Internal Displacement Monitoring Centre 2012 Sanmugam 1993, Gunatilaka 2013 Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 107 Figure 5.21 Female labor force participation A. Developing countries B. Sri Lanka. Female labor force participation rate by age (Percentage of female population ages 15-64) groups percentage, 2002-2012 90 60 80 50 70 40 60 30 50 20 40 10 30 0 15-19 20-24 25-29 30-39 40-49 50-59 60-69 over 70 90 92 94 96 98 00 02 04 06 08 10 12 19 19 19 19 19 20 20 20 20 20 20 20 2002 * 2010* Sri Lanka Malaysia Upper middle income Lower middle income South Asia Vietnam 2006* 2012* Source: World Development Indicators, World Bank C. By education groups, percentage D. By marital status, percentage 90 70 80 60 70 50 60 50 40 40 30 30 20 20 10 10 0 0 Primary Primary O-levels A-levels Degree or incomplete more * * * * * * * * * * * 11 03 04 05 06 07 08 09 10 12 02 20 20 20 20 20 20 20 20 20 20 20 2002 * 2006* Never married Married Separated 2010* 2012* Widowed Divorced Source: Arunatilake et al, 2015. Labor Force Survey data, excluding North and Eastern provinces for comparabilityand Eastern provinces for comparability qualifies as appropriate employment conditions and op- main reason for non-participation in 2012, in line with portunities.113 earlier years. This is similar across urban and rural regions, but less common for young women (who are most often 251. Social norms related to women’s role in the studying) and those in the estate sector (who more often household and especially as related to childcare re- cite old age/retirement). Interestingly, 71 percent of wom- sponsibilities restrict women’s opportunity to partic- en with higher levels of education (A levels or more) cite ipate in the labor market. About 66 percent of women “household activities” compared to 64 of cases for wom- who did not participate cited “household activities” as the en with lower level of education114. Indeed, “marriage de- 113  Malhotra and DeGraff 2000: 149 114  Arunatilake et al (2015) using the 2012 Labor Force Survey. 108 | V. Social Inclusion for Shared Prosperity and Poverty Reduction Figure 5.22 Understanding the gender wage gap A. Real wages by gender B. Decomposing the gender wage gap* 7500 88% 15% 7000 1.9% 86% 10% 8.7% Real Monthly Earnings (2002 Rs.) 6500 5% 84% 7.9% 6000 0% 1.9% Percent of male wages 5500 82% -5% -13.5% 5000 -10% -17.3% 80% 4500 -15% 78% -5.0% 4000 -20% 3500 76% 2006 2012 3000 74% Difference in characteristics Unexplained male premium 2002 2003 2004 2005 2006 2007 2008 2009 2010 2012 2011 Differences of male Differences of female Male Female Ratio female-male (right axis) common support common support Source: Arunatilake et al (2015) using Labor Force Survey data. Data excludes Northern province for comparability. * Decomposition of the gender wage gap using matching, following Ñopo (2008). fines culturally appropriate behavior beyond economic were about four percentage points higher for females than need, individual ability, and individual preference”.115 Most for males in 2012, reflecting a widening over the 2002-to- notably, once married, women traditionally carry care re- 2012 period. Despite higher levels of education for wom- sponsibilities for children and elderly in the household. In en, wages for women continue to be lower than wages for a survey conducted on attitudes towards gender norms in men, with women earning 84 percent of male wages in four districts of Sri Lanka, more than half of the male and 2012 (Figure 5.22A). Even when taking differences in the female respondents agreed that childcare is primarily the types of jobs where men and women tend to be employed mother’s responsibility and that women’s most important into account, the wage gap in 2012 cannot be explained role is to take care of her home and cook for the family.116 by observable characteristics or by differences in the types More generally, perceptions of culturally appropriate em- of work that men and women typically engage in. More- ployment as opposed to the actual opportunities avail- over, this unexplained share has increased since 2003 able may leave women unemployed.117 According to the (Figure 5.22B), which is likely to reduce the willingness of National Youth Survey 2013, 64 percent of young women women to work. As Sinha (2012) highlights, public-sector mention respectability as an important factor in their job jobs have less of a problem in this regard, with the rela- selection.118 Finally, the type of degrees completed could tively better gender parity in earnings in the public sector, play a role, especially when looking at arts degrees.119 making it more attractive for women to seek employment there. In addition, the public sector typically offers shorter Gender Wage Gap and Occupational Segregation workdays – which allow working mothers and wives to at- tend to their household duties while maintaining the per- 252. Beyond social norms, gender wage gaps and oc- ception of respectability – as well as other monetary and cupational segregation dissuade and constrain women non-monetary benefits (maternity leave, vacations, sick from participating in the labor force. Female education- leave, pension benefits, etc.). al achievement is higher and has been growing faster than 253. Discrimination in hiring practices is hard to that of men. For instance, the O-level completion rates prove. However, a Marga Survey conducted in the 1980s, for instance, pointed to biases against married women due to the perceived need for extra facilities and higher costs in the form of absenteeism and maternity leave.120 Finally, 115  Malhotra and DeGraff 2000, p. 145. due to a high degree of occupational segregation based 116  de Mel et al. 2013 117  Amarasuriya 2010 118  UNDP 2014:42 119  Ibarguen 2004 120  Malhotra and DeGraff 2000: 152 Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 109 Figure 5.23 Female labor force participation by location and ethnicity, 2012 A. By location B. By ethnicity 40.7 40.3 42.8 41.8 60 55.0 45 39.5 38.7 Percentage of female labor force Percentage of female labor force 40 35.1 36.9 50 35 39.9 26.2 40 36.9 30 23.6 participation participation 25 29.0 30 20 15 20 16.2 10 10 5 0 0 Sinhala Sri Indian Sri Total a ral rth rn uw No rn en So ral rn rag a rth ern tal Lankan Tamil Lankan ba Uv No este he nt ste rth nt an To No ast -Ce ut Ce Tamil Moor We -W E Sa Source: Arunatilake et al (2015) using Labor Force Survey data. on social attitudes about appropriate jobs for women, make employers bear the entire cost, potentially deterring relatively few occupations, such as teaching, semi-skilled employers from hiring women.125 and unskilled production work (often in textiles) and do- mestic service, are available to Sri Lankan women.121 Some 254. Finally, there are notable differences in female of these jobs, such as working in garment factories in free labor force participation among provinces and eth- trade zones, are associated with exploitation and stigmati- nic groups (Figure 5.23). Participation in the Northern zation, which may deter women from entering into the la- and Eastern Provinces is particularly low at 26.2 percent bor market.122 In addition, the legal framework governing and 23.6 percent, respectively. The special circumstances work in the private sector prevents women from taking up for women due to war and effects of the 2004 tsunami in night work or part-time work in the growing service sec- these regions – including high levels of gender-based vio- tor.123 Moreover, the laws governing maternity benefits124 lence and early marriage to war widowers – may contrib- ute to the problem. Indian Tamil women are much more likely to participate in the labor force – their participation rate lies at 55 percent – and the participation by Sri Lank- an Moor women is lowest, at 16.2 percent. While the high 121  Cited in Malhotra and DeGraff 1997: 382, Gunatilaka 2013:3 participation rate by Indian Tamil women can be explained 122  Amarasuriya 2010 by their location in the estate sector and the special labor 123  The Shop and Office Employees Act No. 19 of 1954 states under conditions there, cultural and social norms in the house- paragraph 10(2) that “a person who has attained the age of fourteen years and who [...] is a female, shall not be employed in or about the busi- hold are likely to play a key role in determining the labor ness of a shop or office before 6 am or after 6pm on any day“. Exception force participation of Sri Lankan Moor women.126 included in the act include: (i) women from the age of eighteen years may be employed in or about the business of a hotel or restaurant for the peri- od between 6pm and 10pm; (ii) women from the age of eighteen may be Female Labor Migrants and Their Families: The employed in a residential hotel before 6am or after 6pm; and (iii) women Inclusion Challenges of Migration from the age of eighteen may be employed in or about the business of a shop or office for the period between 6pm and 8pm. See Shop and Office Employees Act accessed at: http://www.ilo.org/dyn/travail/docs/1350/ 255. One way that women participate in labor has Shop20and%20Office%20Employees%20Act.pdf (April 1, 2015). been through migration, which poses particular inclu- 124  Maternity benefits in Sri Lanka’s private sector are governed by sion challenges. A significant body of literature focuses the Maternity Benefits Ordinance No. 32 of 1939 (for women employed in any trade) and the Shop and Office Employees Act No. 19 of 1954 (for women employed in shops and offices) (Abeykoon et al. 2014). In 1993, Sri Lanka ratified the ILO Maternity Protection Convention (Revised) 1952 or might become pregnant (Abeykoon et al. 2014:4). Furthermore, mater- (No. 103). However, there remain shortcomings between the national nity benefits financed through employer liability are difficult to enforce legislation and the ILO convention (see Abeykoon et al. (2014: 13). One (Abeykoon et al. 2014:4). of the shortcomings is that maternity benefit payments are financed through employer liability. It is commonly argued that employer liability 125  Gunatilaka 2013 for maternity benefits lead to discrimination of women who are pregnant 126  Malthotra and DeGraff 1997 110 | V. Social Inclusion for Shared Prosperity and Poverty Reduction on the well being of female migrants outside Sri Lanka and Figure 5.24 Female representation in parliament the situation of the families they leave behind.127 While the share of women in departures for foreign employ- ment has declined overall since the mid-1990s, women still constituted 49 percent of departures in 2012.128 Out of 7.0% the women migrating for foreign employment in 2012, 86 6.0% percent were to be employed as housemaids. Most female 5.0% migrants are married, have children and come from lower 4.0% income groups.129 Poverty, lack of employment in Sri Lanka 3.0% with adequate wages, the desire to improve the econom- ic status of their families (including building a permanent 2.0% home and acquiring land), better education for their chil- 1.0% dren, and overcoming economic difficulties like indebted- 0.0% ness are often cited as reasons for women’s departures.130 1931-1935 1936-1947 1947-1952 1952-1956 1956-1959 1960 1960-1964 1965-1970 1970-1972 1972-1977 1977-1978 1978-1989 1989-1994 1994-2000 2000-2001 2001-2004 2004-2010 2010-2015 256. Women’s migration has impacts on the family that is left behind, most notably on the children in the household, with implications for society more broad- Source: Parliament of Sri Lanka. Available at: http://www.parliament.lk/en/lady- ly. In the absence of the mother, the extended family and members husbands take up care responsibilities for children in fe- male migrant households.131 With the primary care giver quirements for mother and child, insurance schemes and being absent, children are sometimes found to be more scholarships for children of migrant workers.135 exposed to abuse, including sexual abuse and incest.132 Poor financial management at home can put the benefits Women in Leadership Roles of migration at risk. Some studies find the educational per- formance and attendance of children of migrant mothers 257. Women are under-represented in political life. to be lower.133 Upon the return of the migrating mother, Sri Lanka boasts having produced the world’s first wom- family relationships are often disrupted due to the long an prime minister in 1960, and women have been enjoy- absence of the mother, her exposure to a different con- ing the right to vote since 1931. However, despite the fact text, her newly gained economic power deriving from her that women make up nearly 53 percent of the population, income and changing the power dynamics at home, and they are under-represented in political and public deci- the non-acceptance of all this by other family members, sion-making bodies. Women make up only 5.8 percent of especially by spouses.134 This can ultimately lead to the parliamentarians in the current National Parliament, 4.1 separation of spouses, additionally impacting children’s percent in Provincial Councils and a negligible 1.8 percent opportunities. In response to the realization of these po- in local government, among the lowest in the world, and tential social costs of migrating mothers, the government certainly in South Asia.136 The percentage of women in has put in place regulations, including minimum age re- parliament between the 1930s and the present has never exceeded 7 percent (Figure 5.24). A shift in 1989 to an elec- toral system based on proportional representation, which elsewhere has generally proven more favorable to women, has not led to a significant change in the numbers of wom- 127  Sri Lankan Bureau of Foreign Employment et al. 2013; IOM 2009; Perera and Rathnayaka 2013; Save the Children 2006; Ukwatta 2010 en elected over the years. 128  Sri Lankan Bureau of Foreign Employment 2012 and 2013 258. Women are also under-represented on pri- 129  Sri Lanka Bureau of Foreign Employment et al. 2013: 14, Sri Lanka vate-sector boards. Ratwatte (2012) noted that of the Bureau of Foreign Employment 2013, Save the Children 2006, Gamburd country’s 25 top corporate entities, which have a total of 2008, Jayaweera and Dias n.d., International Labor Organization 2013 198 directors, only 10 are women.137 Although women on 130  Kottegoda 2006: 56, Hettige et al. 2012: 27, Save the Children 2006: 12, Gamburd 2008, Jayaweera and Dias n.d., International Labor Organi- zation 2013 131  International Labor Organization 2013, Jayaweera and Dias n.d., 135  Central Bank 2014 Ukwatta 2010, Kottegoda 2006 136 Kodikara, 2011. Available at https://www.opendemocracy. 132  Save the Children 2006, Perera and Rathnayaka 2013 net/5050/chulani-kodikara/sri-lanka-where-are-women-in-local-govern- 133  Save the Children 2006, Hettige et al 2012, Sarma and Parinduri ment 2013 137  Ratwatte, 2011. Available at http://dbsjeyaraj.com/dbsj/ar- 134  Hettige et al. 2012: 23, Gamburd 2008 chives/11707 Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 111 Sri Lankan corporate boards are valued for what they can the North, East, Moneragala, and the estates. Multi-sec- contribute and in every sense are considered no less equal tor interventions that address lack of job opportunities in to the job than their male counterparts, they take only 5 the North and East would help to reduce poverty and en- percent of leadership roles in the private sector. Similarly, sure shared prosperity. This could include small works pro- a study using 2009 data found that only 13 percent of top grams aimed at improving market accessibility, incentives management positions in nine commercial banks in Sri to promote entrepreneurship among educated youth and Lanka are held by women.138 direct programs to help ex-combatants and female-head- ed households would go a long way to ensuring inclusion of the most vulnerable. In the estates, multi-sector inter- D. Priorities on Inclusion ventions to improve nutrition outcomes, enhance job op- portunities for the youth and prepare for a growing num- 259. The significant locational concentration of mon- ber of aging estate workers would help in ensuring their etary poverty in urban areas points to harnessing the inclusion in shared growth. urbanization process to benefit the poor and the bot- tom 40 percent. The highest numbers of people living 261. Concerted efforts need to be continued to im- in poverty and the bottom 40 percent are located within prove equality of opportunity across ethnic groups, re- multi-city agglomeration areas and can benefit from ef- gardless of where these populations reside. This mainly forts to increase competitiveness discussed in Chapter IV. requires an improvement in job opportunities for ethnic Providing for effective governance of cities to allow for re- minorities. However, it also points to the need to address sponsiveness to changing social and economic conditions land claims in the former conflict areas, providing assis- and addressing inclusion challenges will be important. tance to new and “old” IDPs, equalizing assistance to wid- Local officials will need to have sufficient administrative ows whose families are victims of the conflict regardless authority, financial resources and capacity to delivery ser- of which side they were on and integrated efforts to assist vices and conduct integrated, strategic planning. An em- ex-combatants. These efforts, in addition to improved so- powered local government could be more responsive to cial protection systems (Chapter III) and better job oppor- addressing gaps in service delivery and infrastructure, par- tunities (Chapter IV), will help to provide equality of op- ticularly in addressing connectivity and other constraints portunity and foster inclusion. to agglomeration that will affect the bottom 40 percent’s 262. Critical emphasis is needed on increasing labor ability to secure good jobs. force participation of women and ensuring that they 260. Key priorities to address the inclusion challeng- enjoy equal opportunity accessing jobs as well as polit- es across space, ethnicity and gender include concert- ical and private sector leadership positions. Priorities in ed efforts to reduce poverty, improve public-service this area include improving women’s education and incen- provision and promote employment opportunities in tives for participation through a better alignment of the education women pursue and the demands of the market; reforming legislation that prevents or deters women from being hired; and fostering greater participation of women 138  Gunawaredena, Kennedy (2010). in leadership positions. KEY KNOWLEDGE GAPS ■■ Updating the poverty line to better reflect the basket of essential commodities. ■■ Analysis of spatial spread of economic activity and potential constraints to further spreading, including to un- derserved areas. This could include analysis of how the Colombo- Kandy-Galle corridor evolved and what should learned from that process. ■■ Analysis of poverty trends at the district level. ■■ Adding a panel component to future labor force surveys, tracking a representative sample of households and in- dividuals over time. This will substantially enhance ability to better understand changes in employment, mobility, and structural transformation. ■■ Updating nutritional outcome data to better monitor progress in the estate sector. ■■ Analysis of drivers of persistent poverty in Moneragala. 112 | V. Social Inclusion for Shared Prosperity and Poverty Reduction VI. SUSTAINABILITY Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 113 KEY PRIORITIES FOR SUSTAINABILITY ■■ Sustaining peace and security through long-term reconciliation efforts among Sri Lanka’s heterogeneous society is the sine qua non for progress towards the twin goals. ■■ Developing a more accountable and effective state to follow through on recently initiated governance reforms. ■■ Putting heavier emphasis on direct investment and long-term private-sector flows will be needed to sustain Sri Lanka’s external fiscal position. ■■ Balancing imperatives to preserve its natural assets, provide for health and livability to its citizens (especially in urban areas), and foster growth. ■■ Managing the impact of climate change through adaption, mitigation, as well as strategies that reduce the carbon footprint. ■■ Addressing long-term fiscal sustainability concerns related to population aging. Sustaining Sri Lanka’s Development overhaul now taking place. The third area is economic sta- bility in the context of the external environment. Finally, 263. The prospects for progress towards eradicating Sri Lanka will continue to face environmental challenges, poverty and promoting shared prosperity depend on particularly the risk of climate change. the sustainability of Sri Lanka’s impressive develop- ment trajectory. As with any country, there are risks that A. Social Risks to Sustainability external or internal conditions that have facilitated prog- ress to date do not continue to hold true. There are also Peace and Security risks of the emergence of new factors that can meaning- fully impact progress. 266. Global experience indicates that countries that 264. Some key risks in Sri Lanka’s recent pattern of have recently been in internal conflict are much more growth and progress towards the twin goals have al- prone to outbreaks of new conflict, suggesting that Sri ready materialized and are important constraints Lanka is an “at risk” country. The 2011 World Develop- reviewed in previous sections. These risks include the ment Report found nine out of 10 outbreaks of new con- challenges of sustaining growth based on internal con- flicts in the 2000s occurred in countries that had recently sumption growth and increased public investment; the fis- previously experienced conflict and all civil wars that oc- cal challenge of declining revenues and increasing needs curred since 2003 occurred in countries that previous- for investment in human and physical capital; the lack of ly had been in civil war. Of course, every country has its diversification and the need to develop a more competi- unique circumstances that may or may not make it vulner- tive, open economy that encourages formality and inno- able to conflict. In Sri Lanka’s particular case, the combat- vation; and providing for equality of opportunity and in- ants who challenged the state in previous decades – the clusion of all segments of the population. Risks to social LTTE and, earlier, leftist groups in the south – are no longer sustainability – in particular higher levels of disaffection direct threats following their comprehensive defeat or in- coupled with higher unemployment and levels of distrust tegration into the political mainstream. However, the lack in government among the youth – are evident in the in- of an evident armed threat at present does not ensure no clusion section. For the most part, these areas reflect the new outbreak of conflict in the future. Having won the war, manner in which government policies have shaped the Sri Lanka needs to secure the peace. contours of the country’s economy and opportunities for its citizens. 267. The quantum of impact from conflict makes it a serious risk even if the likelihood of a new outbreak 265. There are four other issues important to sustain- appears low. Conflict inflicts direct and indirect costs at ability and fundamental to continued progress. The national, local and personal levels and lack of security un- first area is the necessity to achieve a lasting settlement dermines the well-being of all Sri Lankans. As noted earlier that ensures peace and security for Sri Lankans. This is in Chapter II, one estimate of the cost of Sri Lanka’s internal the sine qua non condition for progress. The second area conflicts was nearly 5 percent of GDP from 1978 to 2002. involves the challenges inherent in the major institutional Conflict would impair the country’s ability to address the 114 | VI. Sustainability constraints outlined above, from dealing with the fiscal leasing land used by the military in the North and East. The challenge to diversification of the economy. new president was elected with the tacit support of the leading Tamil party and contains leaders from the main 268. Sri Lanka’s Commission of Inquiry on Lessons Muslim parties. Symbolic steps have been taken, including Learned and Reconciliation (LLRC) identified in 2011 a having Tamil party leaders participate in national celebra- broad array of steps to achieve reconciliation among tions for the first time in decades. An international inquiry the country’s communities. These steps focus on: ensur- into accountability issues delayed its reporting in recog- ing rule of law; addressing citizens’ grievances; devolving nition of the policy intent and steps undertaken by the power; upholding language policy allowing for official use government to address reconciliation. There have been of multiple languages; providing for equality of opportu- no notable episodes of inter-communal violence since the nity; and strengthening inter-communal and inter-per- new government was elected. sonal ties. Most important, political consensus to work towards reconciliation by political leaders representing all 271. Yet challenges remain to achieving lasting rec- communities, in and outside of government, is needed to onciliation. A political settlement on the institutional underpin these efforts. These recommendations are con- framework that addresses issues of voice of local commu- sonant with successful experience in breaking the cycle of nities is still to be worked out. In particular, incoherence violence in other countries, namely the need for rebuild- in the assignment of powers between the central govern- ing confidence in the state by providing an institutional ment and provincial government is a source of continuing framework that provides citizens with security, justice, and tension in the North. There is still a large, albeit lessening, jobs.139 military presence that interferes with localities through its surveillance, economic activities, and occupation of land. 269. Much has been done to implement LLRC recom- There has been little progress towards closure on social mendations but much remains to be done. The govern- justice, particularly accountability in connection with al- ment carried out a far-reaching program of resettlement of legations of crimes committed during the conflict, as well those displaced by conflict: as resolution of cases of disappearances. The sensitivity of demilitarization, rehabili- this issue is heightened by the considerable international Much has been done tation and reintegration of attention it attracts. Equality of opportunity that will pro- to implement LLRC ex-combatants; de-mining vide the conditions for citizens of all communities to find of nearly all land; and rapid rewarding jobs is critical to inclusion. While there has been recommendations reconstruction of social and progress in recent years, there is still a gap in opportuni- but much remains to connective infrastructure ties, particularly in more rural, isolated areas. Sustained ef- forts will be needed to address these sensitive issues. be done destroyed by conflict. Prog- ress in these areas has been substantial in the short six Other Social Risks years since the end of the war, though infrastructure and other public goods that provide for equality of opportuni- 272. High levels of unemployment for youth – partic- ty are still at lower levels than the rest of the country. Other ularly educated youth – pose risks to social sustainabil- issues have been partially addressed. These include imple- ity. Declining employment prospects for youth can lead menting a trilingual public service policy and holding East- to frustration and ultimately, tensions.140 Youth seeking ern and Northern Provincial Council elections, as well as government jobs frequently report the influence of social organizing North-South exchange programs for students networks in obtaining them. In the National Youth Sur- and civil society and making efforts to recruit Tamil-speak- vey 2013, 54.4 percent pointed to “political connections” ing local police officers. and 30 percent to “family connections” in obtaining pub- lic-sector employment, signaling an uneven playing field 270. There have been recent renewed efforts to pro- and causing exclusion. In the past, frustrations with social mote inter-communal harmony. Since the change of hierarchy, patronage systems and the unavailability of ap- government in January 2015, several steps have been tak- propriate employment opportunities are argued to have en to address Tamil grievances, such as quickly moving to played a role in tumult involving large numbers of youth appoint a civilian governor, expediting domestic mecha- in Sri Lanka since the early 1970s.141 The same youth sur- nisms to address accountability in connection with allega- vey points to pessimistic views about the political situation tions of crimes during the conflict, and, more slowly, re- 140  Amarasuriya 2010 139  World Development Report 2011. World Bank. 141  Amarasuriya 2010; UNDP 2014 Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 115 of the country and low trust towards public institutions and was widely thought likely to continue for several more among other issues; in 2013, 89 percent said they have lit- years. Public servants and entrepreneurs alike had adapt- tle trust in political parties, up sharply from 47 percent in ed to the policies, institutional framework and governance 1999-2000.142 Continuing disparities in income, consump- style of the previous government, and will need to adjust tion and access to services, which affect ethnic minorities to new circumstances. and create mutual suspicion, can constitute another risk to cohesion. Finally, displacement resulting from conflict and natural disasters has created tensions around land.143 With B. Economic Risks to Sustainability the return of IDPs, land ownership is contested between External Risks returnees and late occupants. In several conflict-affected areas, land rights are being used as a tool to promote po- 275. Achieving a more sustainable external position litical patronage. This can exacerbate inter-ethnic tensions, will require a heavier emphasis on direct investment particularly in areas where minority communities long dis- and long-term private sector flows. In line with the anal- placed are returning.144 Land disputes can also threaten ysis presented in Chapter IV, recent external debt sustain- to undermine the relations between government officials ability analysis146 has highlighted potential vulnerabilities and communities.145 to external sustainability including: (i) a chronic current ac- count deficit and relatively low reserve adequacy metrics; Institutional Change (ii) a gradual but steady decline in goods exports as a share of GDP; (iii) a similar decline in Sri Lanka’s share of world 273. The 19th Constitutional Amendment reflects con- exports; (iv) an already high external debt burden and a sensus to reducing the powers of the presidency, but is rising cost for external financing as Sri Lanka shifts to mid- a major overhaul in the country’s institutional frame- dle-income status and bilateral concessional debt is re- work and will require a period of adjustment. The pas- placed with borrowing on commercial terms; and (v) mod- sage of the 19th Amendment in April 2015 creates stron- est increases in foreign direct investment, which would ger accountability mechanisms through the introduction otherwise alleviate the need for debt financing. While the of a presidential-parliamentary form of government and current account deficit has decreased in recent years, it re- strengthening the autonomy and role of independent mains financed largely by debt-creating inflows and cen- commissions. Additional reforms are expected to insti- tral bank foreign exchange reserves are at the lower end of tute a right to information regime and strengthened audit what is considered adequate by standard metrics. and procurement oversight mechanisms. There is a large degree of political consensus around the need to reduce 276. With the country’s shift to middle-income status, the perceived excessive concentration of power in the concessional borrowing sources are drying up and are presidency and lack of accountability and transparency. being replaced by borrowing on commercial terms. Enacting these institutional changes was a core campaign The authorities have been successful in tapping interna- promise, which helped secure President Sirisena’s elec- tional markets consistently with sovereign bond issues tion in January 2015. Despite contentious debate, the 19th and lengthening the average maturity of the debt portfo- Amendment eventually was nearly unanimously adopted lio.147 Between 2007 and 2014, the government sold USD by Parliament. Notwithstanding this consensus and the 7 billion of sovereign bonds. As a result of increased com- goal of ensuring greater accountability, it remains to be mercial borrowings, the non-concessional and commercial seen how the new framework will operate. There will be a component of the government foreign debt rose from 1 “working in” period as the newly formed Cabinet and inde- percent in 2000 to 50 percent in 2013. Recently, the bank- pendent commissions undertake their roles in a changed ing sector was also borrowing overseas at relatively high institutional framework. yields.148 274. Any such major change is complex and affects the interests of many who may respond in unexpected ways. The prior government was in power for nine years 146  IMF, 2014. 142  UNDP 2014 147  Average Time to Maturity of domestic debt increased from 2.3 to 6.0 years during 2009 to 2013, for foreign debt it increased from 9.3 to 143  Raheem 2013; Internal Displacement Monitoring Centre 2012 10.4 years during the same period. 144  Fonseka 2010; Raheem 2013 148  For example, National Savings Bank borrowed USD 750 million at 145  Raheem 2013 8.875 percent in the year 2013. 116 | VI. Sustainability Long-Term Risks to Fiscal Sustainability Figure 6.1 Elderly dependency ratios, for different demographic scenarios 277. Beyond the fiscal and external risks 120 pointed out throughout this report, an ag- ing population will strain public and external 100 finances in the long term. Sri Lanka is in the midst of its demographic transition, and is pro- 80 jected to age fast in the next few decades. The elderly dependency ratio reached its minimum 60 in the 1970s and 1980s and, thanks to increases in life expectancy, has been rising steadily since 40 then. Under likely population projection scenar- ios, the elderly dependency ratio is set to rise 20 further to about 25 percent by 2020, and could then stabilize around 33 percent under the no- 0 change scenario or rise to 99 percent under the 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 2100 low-fertility scenario (Figure 6.1). Private-sector savings are expected to fall, as the elderly draw down their savings, while increased current fis- Constant fertility Low cal expenditure on aging (health, pensions, and long-term care) will negatively affecting pub- Constant mortality Medium lic-sector savings. As a result, the already low High No change national savings rate would further undermine Instant replacement Zero migration the negative savings-investment balance. Source: UN population projections, Bank staff calculations 278. Population aging will likely impact the fiscal accounts through three channels: tax revenue, fiscal expenditure, and GDP growth. In the countries (Figure 6.2A). The projected share of 60+ in total absence of a tax reform, a decline in the labor force will population as of 2015 is 13.4 percent, but the share of el- lead to falling revenue from income tax. An increase in the derly is projected to increase share of elderly will lead to higher expenditure on pen- to 25.7 percent of total pop- sions, health and long-term care, much of which would be ulation by 2050, an increase Sri Lanka faces a expected to be covered by the national budget. There may of 12.3 percentage points. Sri challenge to “get rich Lanka is also relatively poor given its age. Compared to before getting old” be savings in education expenditure to the extent that only the young receive education, though from the per- spective of improving educational outcomes to increase other Asian countries with a Sri Lanka’s competitiveness, more public expenditure on similar elderly dependency ratio, Sri Lanka’s GDP per cap- education may be needed instead. The combination of fall- ita is low; hence there is urgency to “get rich before get- ing income taxes and increased expenditures will lead to ting old.” Moreover, Sri Lanka’s social expenditure (most of persistent deficits and consequent accumulation of public which is age-related) is relatively small compared to other debt. Increased debt, in turn, will lead to further increases similar-age countries. As shown earlier, expenditure on in expenditure through interest payments. Finally, a slow- health is relatively low and has been declining over time down in labor growth and potentially lower investment (as (Figure 6.2B). Expenditure on pensions is 1.4 percent of discussed above) will lead to a slowdown in GDP growth, GDP -- reflecting its limited scope, which comprises only which will worsen the capacity of the economy to sustain retired public-sector workers. high debt. There may also be feedback effects, where gov- ernment fiscal policy may affect the decision of the elderly 280. Between now and 2060, the elderly dependen- whether to retire or stay in the labor force. cy ratio is projected to rise sharply, while the young dependency ratio is projected to fall. The population is 279. Moreover, Sri Lanka is relatively older and poor- projected to peak in the mid-2040s before starting to fall er compared to other countries facing an aging popu- (Figure 6.3). Life expectancy at birth has increased from 60 lation. Sri Lanka is already a relatively old country, espe- years for the cohort born in 1960 to 74 years for the 2012 cially compared to other South Asian countries, although cohort. The share of the population above 60 will increase its population is still younger than countries in Europe and from 13 percent to 27 percent by 2060 under the medi- Central Asia and a number of middle-income East Asian um-fertility scenario. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 117 Figure 6.2 Aging and social expenditures in international perspective A. Age and aging B. Social expenditure 45 8 Thailand 40 7 Increase in elderly from 2015 to 2050 (60+, % of 35 Vietnam Sri Lanka Education expenditure, public 6 Malaysia 30 Korea ( percent of GDP) 25 5 population) 20 4 Indonesia India 15 Singapore 3 Cambodia Philippines 10 Banglades 2 5 Sri Lanka 0 1 0 5 10 15 20 25 30 35 1 2 3 4 5 -5 Elderly 2015 (60+, % of population) Health expenditure, public (% of GDP) Africa Latin America & Caribbean East Aia & Pacific Middle East & North Africa Europe & Central Asia South Asia Source: UN population projections, medium fertility scenario, staff calculations Figure 6.3 Population projections in Sri Lanka 281. Illustrative simulations of the long-term impact of aging on the fiscal accounts can help shed light on 25,000 70.0% the constraints and policy space available to the gov- ernment.149 A baseline scenario of no tax reform and a pol- 60.0% icy of bringing public health and education expenditure 20,000 50.0% to levels closer to other middle-income countries would lead to a steady rise in primary (non-interest) expenditure 15,000 40.0% from 14 percent of GDP in 2013 to 20 percent of GDP by 30.0% 2060. This widening primary deficit combined with a slow- 10,000 ing GDP growth would lead to a rapidly growing level of 20.0% public debt-to-GDP from 78 percent of GDP at end-2013 5,000 surpassing 150 percent of GDP within two decades. Inter- 10.0% est payments would form the majority of public spending, 0 0.0% which would be clearly unsustainable. -18 -23 -28 -33 -38 -43 -48 -53 -58 -60 14 19 24 29 34 39 44 49 54 59 20 20 20 20 20 20 20 20 20 20 149  Simulations based on publicly available information by Bank staff Population 55+ available upon request. These simulations do not constitute official World Population 15-54 Bank projections. While the current numbers are based on actual data as of end-2013, the projected numbers are based on simple projections of Population 0-14 the tax base (revenue) and projected trends in demographics and cost Young dependency ratio (right axis) inflation (expenditure). It should be noted that these simulations do not take into account the fact that many (informal sector) workers are not Elderly dependency ratio (right axis) covered by neither the public nor the private sector pension scheme, and in the future there may be pressure to extend coverage to those workers Source: Parliament of Sri Lanka. Available at: http://www.parliament.lk/en/lady- as well. Neither do they it include possible future public expenditure on members long-term care. 118 | VI. Sustainability 282. Public policy action may help avert this scenario dition of conservation dating back over 2,000 years when through tax reforms and increasing the retirement age ancient edicts called for the preservation of wildlife in de- in line with rising life ex- fined areas. Its extraordinary variety of landscapes and bio- pectancy. With only about 4 diversity is today relatively unaffected with low levels of A major tax reform to percent of the working-age air, water, and land pollution. For instance, its air quality is gradually lift revenue population paying income the best in South Asia, in large part thanks to its effective tax, there is scope to coun- vehicle emissions control system, though the anticipated could offset the teract the slowdown and doubling of private vehicle traffic between 2010 and 2020 projected increases in eventual decline in the labor and an increase in use of coal for power generation will expenditure, contain force by having more people pay income tax. For other pose an increasing challenge. Sri Lanka’s natural assets provide for high levels of livability and contribute to Sri the fiscal deficit, and taxes, there is also scope to Lanka’s attractiveness for tourism. put public debt back gradually but persistently 286. However, there are environmental challenges to widen the tax base, reduce on a declining path exemptions and improve tax be managed. There has been an increase in arable land collection (Chapter III). A ma- due to the expansion of agriculture at a rate of 2.7 percent jor tax reform that would gradually lift revenue to 22 per- per year between 2006 and 2011, the years for which in- cent of GDP over time could offset the projected increase formation is available150. Correspondingly there has been a in expenditure on education, health and public-sector reduction in forest cover from 33.2 percent in 2000 to 29.7 pensions sufficiently to achieve a primary surplus and con- percent in 2010 (which does not take into account likely tain the fiscal deficit, and put public debt back on a declin- losses in the conflict affected north). Sri Lanka had the ing path. fifth highest rate of deforestation (15 percent) in the world during the period 2000-2005, with consequences for wa- 283. Extending the retirement age could temporarily tersheds and soil loss, and leading to a panoply of eco- boost GDP growth, but its impact would not be enough nomic and environmental damages. A recent 2010 World to reverse the debt dynamics, due to inertia in the la- Bank study found that bor market and demographics. Gradually extending the economic losses from retirement age for public-sector workers could help stabi- land and environmental Economic losses from lize public pension expenditure, but it would have only a degradation far exceed land and environmental small effect on labor market dynamics and GDP growth. the revenue from agri- degradation far (by orders of magnitude) Due to inertia, it would not fix the fiscal deficit as fast as tax reform would. If people work longer across the board, culture, suggesting that exceed revenue from it would temporarily reverse the declining labor force and limits to land conversion expansion of agriculture, income-tax revenue as more people would enter than exit have likely been reached. during the transition. This temporary boost to GDP and This has contributed to suggesting that limits revenue would make the debt dynamics look more favor- high and rising levels of to land conversion have able, but it would not make it sustainable by itself. species extinction; ac- cording to a recent sur- been reached 284. Any reform of this nature will be politically sensi- vey, 33 percent of inland tive and needs to be gradual, but delaying reform will vertebrate fauna and 61 percent of its flora are nationally force more painful actions to be taken later. Tax reform threatened. Fresh water resources are at risk due to en- will not increase tax revenue at once, and such reforms will croachment that occurs in the absence of adequate water- face political economy challenges. However, the sooner shed planning and enforcement. tax revenue increases, the more space there will be for ex- penditure later. Similarly, increases in the retirement age 287. Soil conservation is critical for agricultural pro- can be implemented only slowly, so preparation has to ductivity and particularly for poorer households who start soon. are most dependent on agriculture for their liveli- hoods. The clearing of forests for new lands that cause in- creased runoff and siltation rates in steeply sloped lands as C. Environmental Risks to well as intensive farming practices are linked to declining Sustainability productivity. The Global Assessment of Soil Degradation 285. Sri Lanka has a significant advantage in its rich natural asset base that can be a long-term contributor to growth and quality of life. The country has a rich tra- 150  FAO 2013 Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 119 suggests that nearly 33 percent of Sri Lanka’s land area while enhancing its livabil- is severely or very severely degraded in terms of reduced ity and quality of life for its Holistic, long term agricultural productivity. A Bank study found that the po- inhabitants. This will require planning across tential cost savings of better nutrient management is be- holistic, long-term planning tween US$50 million to 100 million over a 20-year period, across sectors, coordina- sectors is needed to suggesting high economic returns to soil conservation. tion among agencies and a obtain enviromentally 288. Protection of watersheds is vital for agricultur- broad range of stakeholders – including the government, socially and al irrigation, domestic water use, flood attenuation, non-governmental organi- economically forestry, fishing, recreation and other services to the zations, the private sector, equitable growth population and environment. The total annual value of and the general public – and watershed services in the Southern Province is estimated may be served by access to to range from US$2,128 per hectare (ha) in the Muthura- green financing. This will involve seeking to allocate public jawela Marsh to US$12,494 for mangrove forests and to funding and crowd in private-sector funding in pursuit of US$622,845 for coral reefs. In contrast, the estimate by green growth as well as institutional capacity. An import- the Millennium Ecosystem Assessment (MEA) of the aver- ant part of capacity would involve the ability to assess the age annual global value of watershed benefits stands at value of sustainable benefits as well as a monitoring, re- US$3,274/ha. Moreover, the average revenue from paddy porting, and verification methodology. cultivation in Sri Lanka is estimated at only US$750/ha. Thus the payoffs from watershed benefits far exceed the 291. The human-elephant conflict exemplifies envi- marginal financial returns from paddy cultivation – the de- ronmental sustainability challenges. Protected areas fault option in agriculture. Protection of water resources is are of insufficient size and quality to sustain the country’s also vitally important for human health. There are strong elephant population as evidenced by data showing that indications that chronic kidney disease, a disease afflicting over two-thirds of the wild elephant population can be over 10,000 persons, stems from high chemical concentra- found outside the protected area system. Wild elephants tions in domestic and irrigation water supply151. are compelled to graze on agricultural lands to survive, re- sulting in a vicious spiral of conflict with agriculturalists. 289. Sri Lanka’s solid waste management challenge This has reached alarming proportions in many parts of is linked to the rapid pace of urbanization. Waste gen- the dry zone in Sri Lanka, with around 70 humans and over eration is characterized by distinct geographic patterns in 200 elephants killed annually due to the conflict. With in- Sri Lanka, with higher volumes being generated in more creased development and the inevitable erosion of habi- prosperous urban areas and provinces. Collection rates av- tats, the problem is set to worsen unless immediate reme- erage 31 percent whereas other middle-income countries dial action is taken. have average collection rates of 68 percent.152 The bulk of waste is organic, suggesting there is scope for reducing 292. In addition to imperatives to have growth be the pollution load of wastes requiring ultimate disposal, green, the country will need to manage disaster risks. and for employment generation through complementary Sri Lanka’s has a disaster composting activities. Poor management of solid wastes risk profile characterized by Annual average high frequency/low severity in Sri Lanka is a direct consequence of under-investment and corresponding policies. A 2011 World Bank study events and a number of sin- losses from disasters identified a funding gap that is estimated to rise to LKR 1.6 gle large-loss events. Disas- is estimated to be ter risks are associated with billion ($16 million) by 2015 and a further LKR. 4.2 billion several factors, including cli- USD 380 million ($42 million) by 2020. mate change discussed be- 290. Sri Lanka will be well served in seeking to ob- low (though impacts cannot be assessed with specificity), tain environmentally, socially and economically equi- as well as land usage patterns that lead to greater vulnera- table growth – or green growth -- now and long into bility. Annual average disaster loss is estimated to be USD the future, especially in urban areas. The large Colom- 380 million, with floods accounting for an annual expected bo metropolitan region in particular will need to balance loss of USD 240 million. Legislation calls for the establish- these priorities in order to have sustainable urban growth ment of a Disaster Fund as an insurance mechanism, but de facto disaster-related expenditure is provided in an ad hoc manner through supplementary budget allocations. Although the state-owned Sri Lanka Insurance Corpora- 151  Paranagama et al, 2013 tion is the designated insurer for public assets like infra- 152  World Bank, 2011. structure, there is very little insurance of private property 120 | VI. Sustainability Table 6.1 Impact of climate change on rice yield in Sri Lanka Current Rice Yield % Change in 2030 % Change in 2050 % Change in 2080 (kilogram/hectare) Agro Climatic Zone Maha Yala Maha Yala Maha Yala Maha Yala Dry–Low 3,498 3,863 (4.2) (6.5) (16.1) (19.8) (29.1) (34.2) Intermediate–Low 4,865 4,612 (2.7) (3.5) (10.6) (15.1) (24.8) (31.5) Intermediate–Mid 4,992 4,761 (1.9) (3.1) (9.3) (12.7) (22.5) (30.3) Intermediate–Upland 3,492 2,955 (1.3) (2.7) (7.5) (11.4) (20.3) (27.5) Wet–Low 3,910 3,711 (0.9) (1.5) (6.0) (10.4) (19.4) (25.1) Wet–Mid 3,538 2,795 (0.8) (1.4) (3.6) (8.2) (18.3) (23.6) Wet–Upland 3,134 2,706 5.7 3.1 2.1 (2.0) (8.6) (12.4) ( ) = negative. Source: Adopted from Ahmed and Suphachalasai, 2014 (less than 1 percent of residential property is insured), and many sectors of the economy, including power, transport, crop insurance is not widespread either.153 The govern- agriculture and aquaculture, with further impacts on ment is working to improve relevant data collection and health, human settlements, and tourism. Climate change develop a national disaster risk financing strategy. It is also will lead to more occurrences of natural disasters, such as looking to link with social protection benefit distribution droughts, floods and landslides, due to extreme weath- programs to provide benefits quickly to deal with disaster er events.156 Much of the impact will be on agricultural impacts, though this hinges on overall improvement of yields, with a decline in rice yield of as much as 23 percent the social protection system. by 2080 (Table 6.1). Farming districts with heavy reliance on primary agriculture, few infrastructural and socioeco- Climate Change nomic assets (or low adaptive capacity), and high level of exposure to historical hazards are the most vulnerable.157 293. The country will be exposed to long-term effects The vulnerability of rice crops to droughts is expected to of climate change. Model simulations under different sce- increase, especially in the dry and intermediate zones. Tea narios indicate a significant past warming trend of about plantations at low and medium elevations are more vul- 0.75°C per century in annual mean temperatures over the nerable to impacts of climate change than those at high South Asia region.154 Future temperature projections in- elevations. Reduction of monthly rainfall by 100 mm could dicate a steady increase in temperatures across the three reduce productivity by 30–80 kg of tea per hectare.158 periods, with anomalies reaching 4°C–5°C for high-emis- Extended dry spells and excessive cloudiness during the sion scenarios by the 2080s. Warming will be widespread wet season can reduce coconut yield, with annual losses throughout the region by end of the 21st century. Spatial of US$32 million to US$73 million. However, during a high patterns of rainfall change indicate future increases over rainfall year, the economy could gain by US$42 million to eastern and northeastern areas. US$87 million due to high coconut yields. Future projec- tions on coconut yield suggest that production after 2040 294. Low-end estimates show Sri Lanka suffering a may not be sufficient to cater to local consumption.159 1.2 percent loss of annual GDP by 2050 due to climate change, even if measures are taken to address it.155 Chang- es of temperature and rainfall variation will directly impact 156  Statement of Sri Lanka to 18 session of Conference of Parties to the United National Framework Conference on Climate Change-COP UN- FCCC, 2012 153  World Bank, 2014 157  Eriyagama et al 2010 154  Ahmed, M. and Suphachalasai 2014 158  Coast Conservation Department 2006 155  Ahmed and Suphachalasai, 2014 159  De Zoysa and Inoue 2014 Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 121 Figure 6.4 Impacts of a 1-meter sea level rise A. Impacted area B. Impacted population Source: Ahmed and Suphachalasai, 2014. 295. Marine and coastal areas are projected to be sim- in water scarcities in the dry zone.162 Third, climate and ilarly affected. Sri Lanka’s coastal region covers about 23 anomalous weather events are expected to cause a gen- percent of the island’s land area.160 It also accommodates eral increase in the number of cases of both vector- and about 25 percent of the population, and includes a heavy water-borne diseases. The region’s mortality rate – influ- concentration of urban areas, tourism infrastructure and enced by dengue, malaria and diarrhea – would increase industries that are vulnerable to the impact of sea level rise over time as a consequence of climate change. Morbidity and increased frequency of storms and the intensification and deaths from such diseases could increase in the future of coastal erosion due to climate change (Figure 6.4). The under all scenarios.163 impacts on marine and coastal areas have been observed in the alteration of ocean circulation, coral reef ecosys- tems, ocean and estuarine salinity, fisheries and recreation D. Priorities on Sustainability and tourism activities. The effects also include dryland and wetland losses, which impose both physical and economic 297. Sustaining peace and security through sustained risks on coastal communities. reconciliation among Sri Lanka’s heterogenous com- munities is a sine qua non for progress towards the twin 296. Climate change will impact other areas, such as goals. Closure regarding difficult chapters in Sri Lanka’s availability of water, energy, public health. The avail- past is needed to forestall the possibility of new tensions ability of irrigation water is highly vulnerable, especially in emerging. Governments at all levels will need to maintain the dry zone, due to the increase in droughts and the high focus on overcoming issues among the country’s ethnic dependence of agriculture. Vulnerability of drinking water communities that have fueled past violence. This will likely to drought is also widespread. The South/South Central, include sustained implementation of mechanisms to ad- North Western, and North Central regions of the country dress these issues, including domestic mechanisms for as- are particularly vulnerable. Drinking water vulnerability to sessing accountability as well as following through on the floods is prevalent in many areas of the country. Such ar- many LLRC recommendations. It also calls for consistent eas have limited access to piped water and rely heavily on consideration of promoting inclusion and reconciliation groundwater, resulting in high incidence of water-borne across all public programs. diseases.161 Second, hydropower generation will be im- pacted over time. Annual average rainfall has decreased 298. Sustaining momentum to carry through with over the last 57 years at about 7 mm per year, resulting institutional and political reforms will be needed to 160  Rathnayake et al 2009 162  Coast Conservation Department 2006 161  Ahmed and Suphachalasai, 2014 163  De Zoysa and Inoue 2014 122 | VI. Sustainability ensure government effectiveness and stability. At the 300. Long-term sustainability concerns related to an time of writing this SCD, the new institutional framework aging population need to be addressed sooner rather embodied in the 19th Amendment has not yet been imple- than later. Having passed its demographic peak, Sri Lanka mented. Electoral reforms have not yet been finalized and faces an urgency to get rich before it gets old. In addition legislation regarding right to information and the audit to addressing the present acute fiscal challenge, tax reform function are awaiting consideration in Parliament. August to structurally increase fiscal revenue over the long term is 2015 general elections have led to the formation of a new needed to create room for increased public expenditure government, which is now setting policies for the coming on education, health and pensions. Increasing the retire- years. There will need to be sustained commitment by ment age in line with increasing life expectancy would also Sri Lanka’s political leaders to carrying through with the help temporarily reverse the decline in the labor force. new model, overcoming any transitional issues that may emerge, and providing for smooth operation of govern- 301. Sri Lanka will be well served in seeking to en- ment. sure environmentally sustainable growth and better manage disaster risk. This could include soil conserva- 299. A heavier emphasis on direct investment and tion efforts, protection of watersheds, and improved solid long-term private-sector flows will be needed to sus- waste management. This will require holistic, long-term tain Sri Lanka’s external fiscal position. Past reliance planning across sectors, coordination among stakehold- on remittances and external borrowing to maintain the ers, and seeking to allocate public funding and crowd in country’s balance of payments will become harder to sus- private-sector funding in pursuit of green growth. In ad- tain. Remittances are likely to remain at comparable levels dition, a national disaster risk financing strategy will be while there is limited scope for continued borrowing, since needed, along with better integration of disaster relief it will be at commercial rates and the country’s low rev- with social protection benefit distribution programs. enue-to-debt ratios. FDI is important for competitiveness but also to help with balance of payments. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 123 VII. CONCLUSIONS 124 | VII. Conclusions Identifying a Path Forward tion efforts. This diagnostic identifies a range of tax admin- istration and policy issues that may be driving low revenue 302. Sri Lanka’s development trajectory has shown performance, but substantial additional analysis into many impressive gains but there are strong indications that areas, most notably tax exemptions and enforcement, is required. Greater effectiveness and efficiency on the drivers of past progress are not sustainable. The coun- expenditure side through improvements in public-sec- try has experienced strong growth and a rapid reduction tor management can also help increase fiscal space. Ulti- in poverty over the past decade. It has ended a 30-year mately, more fiscal space is a precondition for addressing debilitating internal conflict and rapidly addressed many other constraints. Low revenue has led to a lean and rigid of the needs of the conflict-affected population. It has just budget where low levels of public spending on health, gone through a remarkable democratic transition and has education and social protection undercut Sri Lanka’s past embarked on far-reaching institutional reforms to provide strong gains in human development and leave it less well for greater effectiveness and probity of government. Its equipped to face changing human development needs as human development outcomes remain impressive, even a MIC. This is especially important in light of the need to if continued improvement is becoming more challeng- reduce inequality of opportunity and invest in skills to en- ing. However, the country’s inward-looking growth model hance competitiveness. Beyond increasing fiscal space for based on non-tradable sectors and domestic demand am- these priority projects, there is room to improve efficiency plified by public investment cannot be expected to lead to of spending on social protection and public-sector person- sustained inclusive growth going forward. nel management that undermines the effectiveness of the 303. The systematic diagnostic set out in this re- state. Reducing fragmentation and improving targeting of port points to fiscal, competitiveness, and inclusion the existing social protection system can ensure that every challenges as well as governance and sustainability dollar spent on social protection has a maximum impact in cross-cutting challenges as priority areas of focus for reducing poverty.164 Similarly, improving controls on pub- sustaining progress in ending poverty and promoting lic-sector remuneration and reducing political influence in shared prosperity. These overarching challenges were civil service management could substantially improve the efficiency of public-service delivery. identified through the SCD’s systematic “leave-no-stone- unturned” review of the many possible factors that con- 305. The competitiveness challenge involves many strain or drive progress on the twin goals (Box 7.1). The areas where Sri Lanka can improve performance, with identified challenges represent an aggregate of discrete improving the skill sets of the labor force emerging as constraints identified by the analysis, filtered by five crite- a major constraint for growth and good jobs for the ria: the potential impact on twin goals, the time horizon for bottom 40 percent. Sri Lanka’s educational system, par- this impact, strength of the evidence base, complementar- ticularly at tertiary levels, is not providing a sufficient vol- ities, and whether addressing the constraint is a precon- ume of workers of the quality and skills demanded by the dition for dealing with other constraints. The extent to market. This, in part, reflects low public spending on the which criteria have been met is derived from observation area, but also points to bottlenecks in expanding the avail- of where Sri Lanka’s current performance falls below that ability of university slots, and the adequacy and quality of of appropriate comparator countries (mainly in South and the curricula. Efforts in this regard could include steps to Southeast Asia) and/or the country’s own past, and where ensure: high-quality general education and development Sri Lankan stakeholders have identified major issues over of soft skills; greater private-sector participation in high- the course of drafting the SCD. The resulting list of areas er education, improvements in technical and vocation- may not be an exhaustive tracking of all of the country’s al training; better coordination with potential employer development challenges, but it sets out what is most sig- needs; and that youth are inclined to pursue degrees in the nificant in relation to the twin goals. industries where demand is the highest. 306. Trade policy and a host of land, labor and other Priority Areas of Focus to End Poverty and regulatory barriers further hamper the country’s de- Promote Shared Prosperity in a Sustainable Way velopment. It will be important to review and revise the country’s trade-related policies, including the para-tariff 304. The fiscal challenge is marked above all by con- regime to encourage more foreign trade, simplify the VAT straints brought about by poor revenue collection. and corporate income tax regimes, and reduce or elimi- Chronically disappointing revenue performance and the persistently narrow tax base despite growth is a first order issue. Continued strong commitment to fiscal sustainabili- ty urgently requires long-term domestic revenue mobiliza- 164  Rathnayake et al 2009 Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 125 Box 7.1 Approach to prioritization This Systematic Country Diagnostic was compiled in three phases: (i) a comprehensive gathering and review of existing evidence of constraints and factors towards progress on ending extreme poverty and promoting shared prosperity (the twin goals); (ii) identification of main themes and further research based on knowledge gaps identified in the initial review; and (iii) organizing and prioritizing areas of focus for achieving progress towards the twin goals. A systematic review of potential opportunities and constraints that could affect the twin goals led to the identification of main themes. This SCD is based on a systematic and detailed review of key potential factors impacting progress on the twin goals by using a hybrid framework that combines the Hausman, Rodrik and Velasco (2005) growth diagnostics methodology with the Bussolo and Lopez-Calva (2014) assets-based framework. The systematic review of Sri Lanka’s performance on the 22 factors identified by this framework led to four major themes, which formed the basis for organizing this report: (i) fiscal sustainability and the need to ensure fiscal space for development; (ii) fostering growth and jobs for the bottom 40 percent; (iii) ensuring spatial and social inclusion; and (iv) the importance of more effective and efficient governance. Prioritization was then conducted in two steps. First, throughout the report, prioritization was based on technical factors, including comparisons of Sri Lanka to other countries that are similar or aspirational as a means of prioritizing areas. Areas where Sri Lanka demonstrated relatively strong performance for an LMIC, such as overall access to infrastructure and basic health outcomes were assessed as having less importance as a constraint, but rather reflected opportunities for Sri Lanka to capitalize on in making progress on the twin goals. These opportunities are summarized briefly at the beginning of Chapter IV. The first six chapters of this volume represent the result of analysis that was made against the general criteria of: • The potential impact on ending poverty and on promoting shared prosperity: This assessed its potential impact on ending poverty and ensuring a sustainable increase in the welfare of the less well off. The overall impact on achieving the twin goals will obviously have the highest weighting. • Complementarities: This refers to the degree to which addressing these constraints would have influence across different domains (growth, inequality, sustainability) and/or would magnify the positive impact of addressing other constraints. • Strength of the evidence base behind the impact. This refers to the extent to which there is a compelling argument for particular reforms, with the stronger cases scoring higher priority. • Time horizon of impacts: This refers to the timeframe under which the impact can be expected to be realized, and would seek to balance short- and longer-term impacts. • Preconditions: These are constraints that need to be addressed to unlock wider potential. The second step in the prioritization process involved consultations with a broad set of stakeholders after the completion of a first working draft. These consultations validated the analysis and served to assess the relative importance of the diagnosed constraints and drivers. Over 120 persons from various spheres participated in consultations. Discussions at the consultations were complemented by surveys to ensure a broad range of inputs. On the basis of the consultations and completed analysis, prioritization of areas against the criteria was finalized. A summary of this prioritization is below; for a fuller treatment, please see Annex 1.4. nate export taxes (cesses) on agricultural commodities. agricultural and rural areas; modernizing labor legisla- Continued focus on improving trade facilitation and the tion to encourage easier movement of labor and female logistics environment, including streamlining licenses labor participation; ensuring that the burden to business and permits required to export would help to promote licensing and permits is minimal, particularly in regions export-led growth. Similarly, greater linkages between where this is a problem, such as the North; and providing R&D institutions and networks of entrepreneurs can help for speedier resolution of commercial disputes and en- competitiveness and a more outward-oriented economy, forcement of contracts in court or using alternative-dis- particularly for agriculture. Moreover, there is need to im- pute mechanisms. Bringing larger and more profitable prove the regulatory environment to allow firms to grow, reducing informality and allowing for economy-wide in- firms into the formal system and improving enforcement creases in productivity and allowing firms to reach econo- could help formalization efforts. The definition of priorities mies of scale. Some aspects of the regulatory environment for investment climate reforms to unleash firms’ potential that appear to be significant obstacles are: upgrading the should stem from regular dialogue between the public systems for land tenure and land-use planning in both and private sectors. 126 | VII. Conclusions Table 7.1 Determination of priorities Priorities Rationale FISCAL Reform the tax regime and improve tax administration to improve Fiscal sustainability a key precondition for progress in all areas, revenue performance including macroeconomic stability. Greater fiscal space allows Improve the adequacy and effectiveness of spending for addressing equality of opportunity through increased social Improve the amount of financing and efficiency of social protection spending, especially important for inclusion. Efficiency of social protection has direct impact on ending poverty. Evidence base is strong. COMPETITIVENESS Review and revise the country’s trade-related policies Trade and adoption of new technologies promote diversification, Provide more resources and quality-enhancing management in the external sustainability, and growth, which translates to good education sector to expand skilled workforce and overcome skills jobs. Overcoming skills mismatches contributes to growth and mismatch participation of the bottom 40 percent, including minorities and Promote innovation by establishing linkages between R&D women. Evidence base is strong for skills and trade policy issues. institutions and networks of entrepreneurs INCLUSION Proper urban management and effective governance of cities to Urbanizing areas are associated with growth and absolute majority address locational concentrations of poverty of poor are proximate to these areas. Ensuring continued benefits Multi-sector interventions to reduce poverty and promote of agglomeration will help progress for the majority of the poor. employment opportunities in areas with the highest poverty rates For those living in more remote areas, more targeted interventions (North, East, Moneragala, and Estates) will be needed to ensure equality of opportunity through improved Improve equality of opportunity across ethnic groups, regardless of service delivery and greater participation in the labor force. Evidence where they reside base is very strong. Increase labor force participation of women and ensure equal opportunity in access to jobs, political and private sector leadership GOVERNANCE Improve the regulatory environment to allow firms to grow and Governance has cross-cutting impact on all other challenges. In enhance overall productivity in the economy particular, labor, land, and other regulation create major distortions Review the regulatory role and participation of the public sector in in the economy. The size of the public sector leads to inefficient the economy use of public resources and distorts labor markets. The ability of Improve the efficiency of the public sector government to carry out core functions depends on effectiveness of the public sector. Evidence base is strong. SUSTAINABILITY Sustain peace and security through long-term reconciliation efforts Peace is sine qua non for continued investment, growth, and Develop a more accountable and effective state personal well-being of large segment of the population. Sustaining Place heavier emphasis on direct investment and equity portfolio the state’s institutional capability over the long term is integral flows than debt competent facilitation of private-sector-led growth. Macro-economic and environmental sustainability are preconditions for continued Preserve natural assets and address the impact of climate change progress as well as capitalizing on the country’s asset base. Evidence Address the long-term fiscal sustainability concerns related to of associated risks is strong. population aging Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 127 307. The role and participation of the public sector and regulatory environment, as well reforms of the public in the economy poses further competitiveness con- sector to ensure that the private sector can compete, more straints. Stronger management and strategic oversight of targeted interventions that could ensure women are able the SOE sector is important to ensure that state involve- and willing to pursue careers that are in line with the de- ment is serving a public purpose, does not create too mands in the labor market, and fostering greater participa- much fiscal risk, and is not crowding out the private sector. tion of women in leadership positions. The state should take steps to ensure that the public ser- vice is “fit for purpose” to carry out public-sector functions Cross-Cutting Challenges and not as a mechanism for job creation. The state can play a role that facilitates greater private-sector involvement 309. The governance challenge manifests itself in through the establishment of a robust institutional frame- many ways, which taken together constitute the fun- work for public-private partnerships that would ensure damental constraint on progress on the twin goals. public interests and investor concerns are balanced while Governance issues are cross cutting and underlie in many crowding in private-sector investment and skills. Finally, important ways the three challenges outlined above. Gov- measures to address conflict of interest could reduce neg- ernance is obviously central to the quality and probity of ative impacts of the interconnectedness of government public expenditure as well as to the government’s capaci- with specific businesses. These measures together will ty to provide for equality of opportunity for the poor and help provide an environment conducive to efficiency- and bottom 40 percent to improve their welfare. Moreover, the productivity-enhancing FDI, allowing for less emphasis on quality of governance is integral to addressing corruption targeted incentives. concerns and sustaining public trust. It is also integral to revenue performance, particularly the effectiveness of tax 308. The inclusion challenge is two-fold, recognizing and customs administration. The most prominent manner that absolute numbers of the poor and bottom 40 per- in which governance acts as a constraint is in how the state cent are in urbanizing population centers while rela- carries out regulatory functions for the economy. Policies tive concentrations of poverty are in specific, relatively that orient the economy inward, such as the convoluted remote districts. Forty-three percent of the poor are in tax system, restrictive land and labor market regulation, the districts directly along the Kandy-Colombo-Galle corri- and inefficient subsidies -- and the related quality of ad- dor, which has seen significant agglomeration and associ- ministration thereof -- reflect areas where governance is a ated growth over the past two decades. The challenge will critical constraint. This burden of government regulation be to ensure that the poor and bottom 40 percent are able has led to a large informal sector, which negatively impacts to participate in this growth going forward as a means to improvements in productivity. Governance weaknesses lift themselves out of poverty. Priority efforts in this re- have further led to significant expansion of the public sec- spect include proper urban management in addition to tor’s role in the labor market and certain economic sectors. adequate access to services to ensure the poor living in This expanded role in the economy contributes little to ef- these areas of agglomeration can benefit from economic fective use of the country’s resources or productivity gains, activity in these areas. At the same time, there are “pock- whether it is interventions in agriculture, multiplying tax ets” of high rates of poverty in the North, East, estate sector incentives, or absorbing a significant portion of the labor and Moneragala where equality of opportunity in terms force. Finally, ensuring the provision of key public goods, of access to services and linkages to the labor market are such as infrastructure and public services, is a core func- lower. Efforts to ensure inclusion of these communities tion of government; the extent to which there is inequality could include small works programs aimed at improving in access to such goods reflects areas where strengthened market accessibility, incentives to promote entrepreneur- governance is warranted. The transparency and account- ship among educated youth and direct programs to help ability reform agenda of the present leadership is an im- ex-combatants and female-headed households. In the es- portant opportunity to strengthen governance, though tates, multi-sector interventions to improve nutrition out- this will be a long-term process. comes, enhance job opportunities for the youth, and pre- pare for a growing number of aging workers would help 310. Sustainability risks should be borne in mind in ensuring their inclusion in shared growth. In addition, while addressing constraints to progress on the twin there is need to address land claims in the former conflict goals. The longer-term risks of security and institutional areas, providing assistance to new and “old” IDPs. The lack reform, as well as economic and environmental sustain- of increase in female participation in the labor force de- ability, will require adequate planning and mitigating poli- spite decades of high educational attainment, caused in cies sooner rather than later. Above all, the sine qua non for part by labor practices, is a major cross-cutting issue. Ef- progress on all fronts is a sustained focus on overcoming forts to address this could entail both reforms to the legal grievances that have fed past conflict and, more generally, 128 | VII. Conclusions carrying through on good governance reforms is integral significant indirect effects for the country as a whole and to providing stability. This will likely include sustained im- the bottom 40 percent in particular. At a basic level, great- plementation of mechanisms to address these issues, in- er fiscal space and efficiency of expenditure will allow gov- cluding domestic mechanisms for assessing accountability ernment to be more effective. A growing economy can be as well as following through on the many LLRC recommen- expected to provide jobs for the bottom 40 percent and an dations. It also calls for consistent consideration of promot- environment conducive to addressing specific inclusion ing inclusion and reconciliation across all public programs. challenges, which, in turn, provides for sustainability. External sustainability is integral to macroeconomic sta- bility, and will require structural reforms that allow for in- 313. There are particularly important areas of syner- creases in FDI and long-term private-sector flows instead gy that provide for progress on inclusion, sustainabil- of external borrowing. Long-term fiscal sustainability giv- ity and growth. For instance, effective governance of cit- en the aging population will require planning in order to ies will not only be critical for addressing spatial inclusion meet declining revenues and increasing expenditures due challenges, but could also improve the benefits of urban to this demographic change. Long-term improvement in agglomeration and raise the level of overall growth and revenue and increasing the retirement age in line with job creation. Good governance in urbanizing areas is also increasing life expectancy would help to avoid major ad- important to balance social, environmental, and economic justment in the future. Finally, Sri Lanka will be well served equity concerns to allow for Sri Lanka to benefit long term in seeking to ensure environmentally sustainable growth from its relatively unharmed natural asset base. Improving and better manage disaster risk. This could include soil partnership between the public and private sectors will conservation efforts, protection of watersheds, improved facilitate more private-sector-led growth and can crowd solid waste management, and holistic, long-term planning in financing of public goods to lessen the fiscal burden to promote green growth. In addition, a national disaster on the state. Similarly, improving equality of opportunity risk financing strategy will be needed, along with better in- (including addressing land claims) across ethnic groups tegration of disaster relief with improved social protection is likely to be crucial for improving social stability and the distribution programs. sustainability of peace. Moreover, closing the gender gap in labor force participation is not only important in terms 311. These challenges are in many cases areas of op- of social inclusion, but is, in effect, critical in terms of the portunity for the next five years. The constraints iden- broader challenge of raising competitiveness and ensur- tified in this diagnostic are issues that can realistically be- ing shared prosperity, particularly given an aging popula- gin to be addressed in the coming years through policy tion will increase the dependency rate. changes and improvements in capacity. Raising revenues is much easier than cutting expenditures, and there is sig- 314. There is a nexus of issues around providing for nificant global experience to draw upon. Trade liberaliza- skills development that meets the needs of Sri Lanka’s tion is possible, as Sri Lanka itself demonstrated in the late economy going forward. On the one hand, there are 1970s and 1990s, though this will need to be accompanied important elements of state performance that need ad- by regulatory reforms in land and labor markets to ensure dressing to improve the population’s skills mix: its ability that the private sector can truly be competitive. Sri Lanka to create more fiscal space to provide quality education has advantages that should make it attractive for FDI; the to the population; the efficiency of resources directed to- administrative steps to become more attractive have been wards human capital development; its ability to listen to demonstrated by many of its MIC competitors in Southeast and partner with the private sector on ensuring that the right skills are being provided, both by public and private Asia. More granular understanding of the specific needs of institutions; and the impact that the state has on the la- the poor and how they can participate in labor markets bor market given its outsized role as an employer. At the should allow for more efficient use of resources in provid- same time, investment in skills, particularly with public fi- ing of infrastructure and services that lead to equality of nancing, is integral to equipping the bottom 40 percent opportunity. There is much that Sri Lanka can realistically with capacity to get good jobs, a fundamental means of accomplish that will allow for it to capitalize more fully on boosting shared prosperity. A more skilled labor force in its location, natural endowments, and human capital. turn helps Sri Lanka become more competitive, including within global value chains, as well as a more attractive as a Synergies destination for FDI. 312. The areas of priority identified above are high- 315. Addressing the constraints and sustainability ly interrelated. Because the constraints go to the core of issues diagnosed in this report will require effective how Sri Lanka’s government and economy function, prog- leadership. Consultations conducted while preparing ress in reducing these constraints can be expected to have this diagnostic showed strong consensus around Sri Lan- Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 129 ka’s development challenges as they are articulated here- carrying through with strong governance to implement in. Indeed, with regard to some constraints, reforms or them will be challenging, as vested interests are likely government intervention have been initiated to address to resist change. While the challenges are clear, effective problems such as equality of opportunity in underserved leadership will be needed to address them and put Sri areas or improving Sri Lankans’ skill sets. The government Lanka on a path that will revitalize its progress in ending has articulated further plans to address other constraints poverty and promoting shared prosperity. outlined in this diagnostic. However, enacting reforms and 130 | VII. 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Studies of Sri Lanka. 136 APPENDIXES Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 137 APPENDIX 1 PERFORMANCE ON THE MILLENNIUM DEVELOPMENT GOALS, INTERNATIONAL COMPARISON Goals and Indicators Sri Lanka Base Sri Lanka Sri Lanka SAR (latest South Eastern Vietnam India Targets Year Latest Year Country Progress data) Asia (latest data) (latest data) (as of 2014) (latest data)     Value Year Value Year Value Year Value Year Value Year Value Year GOAL 1: ERADICATE EXTREME POVERTY AND HUNGER Reduce extreme Proportion of population 15 1991 4.1 2010 low poverty 29.7 2010 14.3 2010 16.9 2008 32.7 2010 poverty by half living below $1.25 (PPP) per day (percent) Reduce hunger Proportion of population 30.6 1991 24.6 2013 Moderately high 16.8 2011- 10.7 2011- 12.89 2013 15.2 2013 by half below minimum level of hunger 2013 2013 dietary energy consumption (percent) GOAL 2: ACHIEVE UNIVERSAL PRIMARY EDUCATION Universal Net enrollment ratio in 99.8 2001 93.9 2012 High enrollment 94.4 2012 93.9 2012 98.2 2012 98.9 2011 primary primary education (enrollees schooling per 100 children) GOAL 3: PROMOTE GENDER EQUALITY AND EMPOWER WOMEN Equal girls’ Ratio of girls to boys in 0.97 1990 1 2012 Parity 1 2012 0.99 2012 1.01 2012 1.02 2011 enrolment in primary education primary school Women’s Share of women in wage 30.2 1997 30.4 2012 Medium share 19.8 2012 38.5 2012 40.4 2004 19.3 2010 share of paid employment in the non- employment agricultural sector Women’s equal Proportion of seats held 4.9 1990 5.8 2014 Very low 16 2014 18.4 2014 24.3 2014 11.4 2014 representation by women in national represent-ation in national parliament (single or lower parliaments house only - percent) GOAL 4: REDUCE CHILD MORTALITY Reduce mortality Under-five morality rate 21.3 1990 9.6 2013 Low mortality 55 2013 29 2013 23.8 2013 52.7 2013 of under-five- (deaths of children per 1,000 year-old by two births) thirds GOAL 5: IMPROVE MATERNAL HEALTH Reduce maternal Maternal mortality ratio 49 1990 29 2013 Low mortality 190 2013 140 2013 49 2013 190 2013 mortality by (maternal deaths per three quarters 100,000 live births) Access to Contraceptive prevalence rate 66.1 1993 68.4 2007 57 2012 63.1 2012 77.8 2011 54.8 2008 universal (percentage of women aged reproductive 15-49, married or in union, health using contraception) High access to Unmet need for family 18.2 2000 7.3 2007 reproduc-tive 14.4 2012 12.5 2012 4.3 2011 20.5 2008 planning (percentage of health women aged 15-49, married or in union, with unmet need for family planning) 138 Goals and Indicators Sri Lanka Base Sri Lanka Sri Lanka SAR (latest South Eastern Vietnam India Targets Year Latest Year Country Progress data) Asia (latest data) (latest data) (as of 2014) (latest data)     Value Year Value Year Value Year Value Year Value Year Value Year GOAL 6: COMBAT HIV/AIDS, MALARIA AND OTHER DISEASES Halt and begin HIV incidence rate (number 0.01 2001 0.01 2012 0.02 2012 0.03 2012 0.02 2012 to reverse the of new HIV infections per year spread of HIV/ per 100 people aged 15-49) AIDS Low incidence Halt and reverse Number of new tuberculosis 66 1990 66 2012 178 2012 202 2012 147 2012 176 2012 spread of cases per 100,000 tuberculosis population Number of tuberculosis 7.5 1990 1.1 2012 24 2012 25 2012 20 2012 22 2012 deaths per 100,000 population GOAL 7: ENSURE ENVIRONMENTAL SUSTAINABILITY Reverse loss of Proportion of land area 36.4 1990 28.8 2010 Medium forest 14.5 2010 49.3 2010 44.5 2010 23 2010 forests covered by forest ( percent) cover Halve proportion Proportion of population 67.6 1990 93.8 2012 91 2012 89 2012 95.2 2012 92.6 2012 without using an improved drinking improved water source ( percent) drinking water Halve proportion Proportion of population 42 2012 71 2012 75 2012 36 2012 without using an improved sanitation High coverage sanitation facility (percent) Improve the Proportion of urban 35 2012 31 2012 35.2 2009 29.4 2009 lives of slum- population living in slums dwellers (percent) GOAL 8: DEVELOP A GLOBAL PARTNERSHIP FOR DEVELOPMENT Internet users Internet users per 100 0 1990 21.9 2013 High usage 12.3 2012 24.9 2012 43.9 2013 15.1 2013 inhabitants Note : The MDG Country Progress Snapshot provides an overview of the progress achieved at country level since 1990 towards the Millennium Development Goals. The snapshot is intended mainly to provide the international community easy access to the information and are not meant to replace in any way the country profiles produced at the national level in several countries. They are also meant to reflect the contribution of country-level progress to the global and regional trends on progress towards the MDGs. The data used in the snapshot are from the MDG global database (http://mdgs.un.org/unsd/mdg/Data.aspx). The metadata and responsible agencies can be found on http://mdgs. un.org/unsd/mdg/Metadata.aspx. Sources of discrepancies between global and national figures are due to, among others, different methodology and definitions or different choice of data sources. At the global level, the monitoring of the progress aims to ensure better comparability of data among countries. Sources: http://mdgs.un.org/unsd/mdg/Resources/Static/Products/Progress2014/Snapshots/IND.pdf; http://mdgs.un.org/unsd/mdg/Resources/Static/Products/Progress2014/ Snapshots/VNM.pdf; http://mdgs.un.org/unsd/mdg/Resources/Static/Products/Progress2014/Snapshots/LKA.pdf Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 139 APPENDIX 1.2 POVERTY INDICATORS FOR SRI LANKA How is Poverty measured? The official poverty figures in Sri Lanka refer to the share of individuals whose per capita consumption falls below the of- ficial poverty line. This indicator is usually defined in the literature as headcount index and it is a measure of the incidence of poverty. The data used for the analysis are drawn from the Household Income and Expenditure Survey (HIES), which has been collected every three to five years since 1995. The 2012/13 HIES covers all 25 districts for the first time in the history of the Sri Lanka household budget survey. The consumption aggregate is the sum of the consumption expenditures of all food and nonfood items of each house- hold. The consumption aggregate is spatially deflated to take into account differences in the cost of living of the different districts. To get the per capita consumption, the spatially deflated consumption aggregate is divided by the number of household members (excluding the persons who are member of the household but usually live elsewhere in the country or abroad). Once per capita household consumption is calculated, it is then compared to the national poverty line, which was set to Rs 1,423 in 2002, equivalent to the minimum necessary to consume 2,030 kilocalories per capita per day (using the Cost of Basic Needs approach). The poverty line has been subsequently updated using the Colombo Consumer Price Index. The World Bank uses as extreme poverty line $1.25 a day in 2005 ppp terms, which represents the mean of the poverty lines found in the poorest 15 countries ranked by per capita consumption among 88 surveyed countries over the period 1990- 2005 (Ravallion, Chen and Sangraula, 2009). The Sri Lanka national poverty line is about $1.50 a day in 2005 ppp. Other commonly used poverty lines for international comparisons across middle-income countries are $2.50 a day and $4 a day in 2005 ppp, which correspond to, in turn, Rs 6,058 and Rs 9,692 a day in 2012/13 prices. In addition to the national poverty line, The SCD will use the US $1.25, US $2.50 poverty lines. The poverty gap and severity of poverty Although the headcount index is the most widespread measure of poverty, it has a serious shortcoming in that it does not take into account the intensity of poverty, i.e. how far from the poverty line the poor are. A measure of poverty that over- comes this problem is the poverty gap index. The poverty gap index is the average shortfall of the total population from the poverty line as a share measured as a percentage of the poverty line itself. The severity of poverty is a measure that puts a higher weight on households furthest away from the poverty line. Both of these measures will complement the analysis of headcount poverty in the context of the SCD. What is the consumption cut-off line for the bottom 40 percent? Finally, the SCD will focus on the bottom 40 percent to discuss the welfare of the less well-off more broadly. The con- sumption cut-off line for the bottom 40 percent (the threshold below which the poorest 40 percent of population lays) in 2012/13 is Rs 6,765, or $ 2.79 a day in 2005 ppp. Key issues with consumption calculations in Sri Lanka There are three main concerns about the methodology followed for building the official consumption aggregate. First, the consumption aggregate includes some items that are usually excluded, in particular: expenditure on durable goods, rare- ly incurred expenses (e.g. weddings, funerals, ceremonies, litigations, purchased properties), and expenses on provident funds, insurances, payment of debts, money lending and income taxes are typically excluded (see Deaton and Zaidi, 2002). Second, to guarantee comparability across surveys, the consumption aggregate should exclude items that were not includ- ed in previous years’ questionnaires, or those for which the recall period has changed over time. Third, since the survey is conducted over a period of 12 months, the use of a temporal price adjustment would be recommended. 140 APPENDIX 1.3 SRI LANKA. CHARACTERISTICS OF THE POOR Bottom Top Poor Overall 40 60   percent percent National US1.25 US2.50 Average age 33.0 31.0 34.3 29.1 28.4 30.7 Average household size 3.9 4.4 3.6 4.9 5.0 4.5 (percent of individuals) Industry1             Agriculture 30.7 41.9 23.0 48.8 47.9 43.2 Industry 23.8 24.9 23.1 23.8 21.4 24.5 Services 45.3 32.8 53.9 27.2 30.7 31.9 Education             Average years of education for             Head 8.2 6.6 9.1 5.5 5.4 6.4 Individuals age 20 or more 8.9 7.5 9.7 6.5 6.3 7.3 Health             Average distance (Km)             Clinic 2.4 2.9 2.1 3.5 3.5 3.0 Dispensary 2.1 2.8 1.6 3.5 3.4 2.9 Hospital 6.6 7.5 6.0 8.2 8.5 7.6 Maternity clinic 5.2 6.0 4.7 6.3 6.1 6.0 Access to services             Share of households with: (percent of households) Electricity 90.2 82.2 94.5 69.2 65.5 80.4 Landline telephone 36.7 21.7 44.8 13.0 9.5 19.8 Mobile telephone 81.1 71.4 86.4 56.5 50.4 70.1 Pipe borne line nearby their house 62.2 54.9 66.2 49.8 48.6 53.7 Tap water 30.9 22.5 35.5 17.8 16.2 22.0 Toilet available within the unit 47.0 36.2 52.9 32.2 31.4 35.9 Sealed toilet connected to sewage 3.6 2.1 4.5 2.4 2.8 2.1 Sealed toilet connected to pit/tank 93.1 92.6 93.4 87.1 85.2 91.9 Source: Own estimates, HIES 2012/13 1/ Refers to the industry where the Household Head is employed. All unclassified industry sectors are assigned to Services Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 141 APPENDIX 1.4 METHODOLOGY This Systematic Country Diagnostic was compiled in three phases: (i) a comprehensive gathering and review of existing evidence of constraints and factors towards progress on ending extreme poverty and promoting shared prosperity (the twin goals); (ii) identification of main themes and further research based on knowledge gaps identi- fied in the initial review; and (iii) organizing and prioritizing areas of focus for achieving progress towards the twin goals. A guiding principle was to have broad participation and feedback from the World Bank Group’s Sri Lanka country team as well as external experts and stakeholders to ensure completeness of data collection and analysis. Thus, following an initial desk review of evidence, a series of brainstorming sessions were held with a broad team of stakeholders. Ultimate- ly an additional 14 background papers and notes were also either commissioned independently or completed in parallel and utilized for the SCD. Figure A1 Diagnostic framework End extreme poverty and Promote shared prosperity Return to economic activity Access to finance Assets Returns to Assets Domestic Local finance saving + international Physical finance Human capital capital Competition Cost Social Natural Government Market inclusion Capital Performance Performance Risk Markets Competitiveness for the poor Contextual Factors Politics and Institutional Framework Marshalling evidence A hybrid framework combining the Hausman, Rodrik and Velasco (2005) growth diagnostics methodology with the Bussolo and Lopez-Calva (2014) assets-based framework was used to identify a set of possible constraints and drivers towards progress on the twin goals. The Hausman, Rodrick and Velasco (2005) growth diagnostic is a top-down approach based on a simplified growth model that identifies for several potential distortions.165 In order to focus on the ability of the bottom 40 percent to latch on to the growth process, this top-down approach was combined with the princi- 165  Following Dixit (2007) we do not use the framework as a decision tree, but rather as a way to organize and discipline the analysis by identifying the range of possible constraints and drivers. 142 Figure A2 Digging deeper End extreme poverty and promote shared prosperity Assets Returns to Assets Access to finance HumanCapital Physical Capital Government Market Performance ■■ Domestic savings ■■ Education/skills ■■ Power Performance ■■ Competitiveness ■■ International ■■ Health ■■ Transport ■■ Government -- Exports finance ■■ Nutrition ■■ Connectivity effectiveness -- FDI ■■ Local finance ■■ Water/ ■■ Macro management -- Industrial -- Cost sanitation ■■ Equitable fiscal incentives -- Risk policy -- Competition ■■ Managing risks ■■ Markets for the Social Inclusion Natural Capital -- Social safety nets poor and bottom ■■ Ability ■■ Land -- Pensions 40% ■■ Opportunity ■■ Environment -- Disaster risk -- Labor markets ■■ Dignity /Natural mgmt -- Rural markets Resources ■■ Regulatory environment ples of the Bussolo and Lopez-Calva assets framework. The Bussolo/Lopez-Calva framework postulates that the incomes of the bottom 40 percent depend on the level of assets – human, physical, financial, social and natural capital – that people own and accumulate, the intensity with which they are used, and the returns associated to those assets. The method aims to consider the constraints as well as facilitating factors to asset accumulation and their use. These have a direct impact on the income generation capacity of all households in an economy, but particularly on the poor and those belonging to the bottom 40 percent of the income distribution. The framework in Figure A1 thus places shared prosperity as the desired goal, which in turn depends on economic growth and the ability of the bottom 40 percent to benefit from growth. The framework provides a breakdown of the range of possible factors contributing or constraining achievement of this out- come. The returns to economic activity depend on the availability of assets and the returns to those assets. Assets include human, social, natural and physical capital, with a focus on the bottom 40 percent. Human capital includes health, edu- cation and nutrition (Figure A1). While “social capital” refers to a specific concept and attendant literature, in fact issues of social inclusion are central to acquiring and using assets. Social inclusion is defined as “improving the terms of individuals and groups, disadvantaged on the basis of their identity, to take part in society”.166 This can be achieved by improving the ability, opportunity, and dignity of such people, who are disadvantaged, inter alia, on the basis of their gender, age, disabil- ity status, caste, ethnicity, marital status or sexual orientation. Natural capital refers to access to land, a clean environment, and natural resources such as forests and fisheries. Physical capital refers to access to basic infrastructure, including roads, ports, electricity, water, and sanitation. It is also important to note that that there is a strong non-monetary dimension to “shared prosperity”. That is, the growth impact of health, education, social inclusion and natural capital may not be very 166  World Bank 2013 Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 143 large, but their impact on “well-being” may be huge.167 Health, education, social inclusion and the environment matter for their intrinsic value, not just for their instrumental value to boost growth. The returns to economic activity also depend on the returns to those assets, which in turn depend on government performance and performance of the market. Government performance is reflected in its ability to (i) maintain macro- economic stability; (ii) ensure the effective provision of public goods and services; (iii) provide a regulatory environment that provides a level playing field that facilitates economic activity; and (iv) mitigate individual risks through a social pro- tection system and addressing systemic risks. Market performance depends on whether there are barriers to competition in domestic markets as well as export competitiveness of the economy as a whole, the ability to innovate, and whether there are distortions in markets that constrain growth of the bottom 40 percent. Special attention was paid to the labor and agricultural markets given their effects on the bottom 40 percent. Each of these potential constraints or areas of strength was considered, evaluating the relative strength of each as a threat to future efforts to end poverty and ensure shared prosperity. Access to finance depends on the availability of domestic savings and access to international finance. It also depends on whether there are bottlenecks in local finance with respect to high cost of finance, high risk (or poor risk management), insufficient competition, issues with banking intermediation, or lack of financial literacy. The framework provides a means to “leave no stone unturned” while also unbundling interrelated issues, which in turn allows for greater specificity as well as comprehensiveness. Many of the possible constraints or drivers are inter- related or cross cutting. This is particularly the case with government performance. For instance, the government’s ability to finance (or attract private-sector financing) and organize the delivery of public goods and services has a direct impact on the quality and quantity of assets held by the poor, and its performance as a regulator affects markets and the cost of finance. For the purposes of this SCD, performance of government was reviewed in terms of core government functionality and capacity whereas its specific impacts in areas such as improving human capital were addressed in those respective sections. Similarly, social inclusion concerns are cross cutting. They are, however, distinct in their core interest in individuals and groups disadvantaged on the basis of their distinguishing features and how their ability, opportunity and dignity to own, accumulate and use assets and generate returns from them can be improved. Identification of main themes and prioritization Prioritization was conducted in two steps. First, analysis of technical issues and outputs/outcomes among possible constraints or, conversely, strong performance along each of the 22 dimensions identified in the framework pointed to the relative importance of a given issue. Where possible, this analysis was complemented by comparisons of Sri Lanka to its past performance as well as to other countries that have similarities and/or are aspirational for the country, primarily in South and Southeast Asia. While differences in Sri Lanka’s performance compared to others did not necessarily mean the presence of a constraint, in cases where the country was an outlier often did indicate areas of relative weakness. This process led to the identification of four main themes in the context of wide consultation, both within the Bank as well as through brainstorming sessions with multiple stakeholders in Sri Lanka. The information and analysis gathered were then weighed against five criteria: ■■ The potential impact on ending poverty and on promoting shared prosperity: This assessed its potential impact on ending poverty and ensuring a sustainable increase in the welfare of the less well off. The overall impact on achieving the twin goals will obviously have the highest weighting. ■■ Complementarities: This refers to the degree to which addressing these constraints would have influence across dif- ferent domains (growth, inequality, sustainability) and/or would magnify the positive impact of addressing other con- straints. ■■ Strength of the evidence base behind the impact. This refers to the extent to which there is a compelling argument for particular reforms, with the stronger cases scoring higher priority. ■■ Time horizon of impacts: This refers to the timeframe under which the impact can be expected to be realized, and 167  Becker, 1964, 2007 144 would seek to balance short and longer-term impacts. ■■ Preconditions: This would identify constraints that need to be addressed in order to unlock wider potential. The second step in the prioritization process involved consultations with a broad set of stakeholders after the com- pletion of a first working draft. The team carried out several rounds of consultations among focal points representing global practices, cross-cutting solutions areas, and IFC operations regarding the draft of the analysis and solicited input on priorities, based on the above criteria. External consultations on the analysis in the text and to identify priorities were held with a broad range of stakeholders in government ministries and departments, think tanks, other civil society groups, rep- resentatives of the private sector, and development partners. Consultations were held in Colombo and in Jaffna to capture a broader range of views. The consultations both helped to validate the analysis in the SCD and to help assess the relative importance of the diagnosed constraints and drivers. On the basis of feedback from all consultations, the team substantiated priorities against the five criteria. The final- ization of priorities against criteria is articulated in the tables below. Matrix of Identified Priorities 1. FISCAL Key Priorities in Fiscal Reforming the tax regime and improving tax Improve the adequacy and Improve the amount of financing and administration to improve revenue performance effectiveness of spending efficiency of social protection IMPACT ON TWIN Ensures fiscal sustainability, and therefore macroeconomic More rational public spending will allow An increase in the amount of funding GOALS stability, a precondition for poverty reduction. for greater resources to be directed at and better targeting of existing social improving human capital and enhance protection can ensure maximum impact in Reduces the risk of undercutting, and increases the ability and spending on social welfare needs, reducing poverty for relatively low levels to increase, investment in human development. thereby reducing poverty. of financing. TIME HORIZON Short to Medium-term Medium-term Short-term Short-term: Reforming tax regime, including rationalizing An even modest increase in the amount exemptions and streamlining tax policy, could improve of financing and better social protection revenue more quickly targeting will reduce poverty among the most vulnerable. Medium-term: Reforms to tax administration and expanding the tax base would strengthen tax collection and help sustainable revenue generation in the medium-term. COMPLEMENTARITIES Reforming tax regime and administration could improve Frees up fiscal space to enhance spending Improved social protection will allow for business climate and enhance competitiveness. on human capital investments. greater participation of the poor in the economy EVIDENCED-BASED Moderate. Strong. Strong. Visible decline in tax collection and proliferation of Evidenced by emerging gaps in health Evidenced by the undesirable exemptions. However, additional analysis into revenue and education provision. More evidence distributional impact of poorly targeted impact of tax exemptions and compliance issues and required on effectiveness of spending social protection schemes. collection vulnerabilities is merited. on infrastructure in terms of rate of return and impact on access and poverty reduction. ESSENTIAL Yes Yes Yes PRE-CONDITION Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 145 2. COMPETITIVENESS Key Priorities on Review and revise the country’s trade-related Provide more resources and quality- Promote innovation by establishing linkages Competitiveness policies enhancing management in the education between R&D institutions and networks of sector to expand skilled workforce entrepreneurs IMPACT ON TWIN Greater trade openness would enable export Improving the skills of the labor force can By enhancing firm-level efficiency and GOALS growth and diversification of the economy, improve opportunities for the bottom 40 competitiveness, innovation can create jobs thereby generating more and better jobs and percent, particularly among youth, to access in industries that will grow in a competitive promoting shared growth. good jobs in industries that will grow in a economy. Agricultural innovation can particularly competitive economy. benefit the poor. TIME HORIZON Medium-term Medium-to long-term Medium- to –long-term Medium-term: Expanding vocational training Medium-term: Connecting entrepreneur and matching skills with industry needs can networks to existing R&D facilities will benefit address the skills shortage in the medium-term competitiveness in the medium-term Long-term: Reforms to education management Long-term: A sustained increase in R&D and expanding tertiary education will foster spending and promoting innovation will have a more competitive workforce with long-term longer-term competitiveness impacts impacts. COMPLEMENT A more outward-oriented trade policy can A skilled labor force can enhance Greater innovation among firms will amplify amplify the gains from rebalancing towards a competitiveness and efficiency of firms, gains from trade openness, in promoting -ARITIES stronger private sector role in the economy, and promoting overall growth. It will also be competitiveness in exports and economic enhance overall economic growth. important complement to greater trade diversification. openness and promoting exports. EVIDENCED-BASED Very strong. Very strong. Moderate. Evidenced by the stagnant economic and export As evidenced by the substantial number of firms R&D and innovation lag well behind diversification alongside the recent slide towards reporting lack of skilled labour as a constraint. comparator economies, and is influencing inward-looking policies. the visible stagnation of export and economic diversification. ESSENTIAL Yes Yes No PRE-CONDITION 146 3. INCLUSION Key Priorities in Inclusion Proper urban management Multi-sector interventions to Improve equality of Increasing labor force and effective governance of reduce poverty and promote opportunity across ethnic participation of women and cities to address locational employment opportunities in groups, regardless of where ensuring equal opportunity concentrations of poverty the North, East, Moneragala, and they reside in accessing jobs as well as estates political and private sector leadership positions IMPACT ON TWIN GOALS As most of the poor and bottom 40 Improving job opportunities Improving economic Enables women to access percent are located within multi- and better access to markets and opportunities for ethnic better jobs and improve overall city agglomeration areas, proper services would reduce poverty minorities, as well addressing inclusion of women in the urban management and adequate and promote shared prosperity post-conflict issues related to economy. access to services will be important in isolated regions. In the estates, land, IDPs, war widows and for the poor living in these areas to improving nutrition outcomes, ex-combatants, would reduce benefit from agglomeration. better job opportunities for the poverty and foster inclusion, youth, and preparing for an aging towards more shared growth. population will ensure inclusion. TIME HORIZON Medium- to long-term Medium-term Short- to medium-term Medium- to long-term Short-term: Addressing pressing Medium-term: Reforming labor issues, such as access to laws that disincentivize female basic services in post-conflict participation can have short- communities can have short-term term positive impacts impacts on poverty reduction Long-term: Impacts of better Medium-term: Impacts from alignment of the education improving job opportunities women pursue and the for ethnic minorities will be demands of the market would seen over a more medium-term be seen in the longer-term. horizon. COMPLEMENT Improved governance of cities Improving human development Improving job and income Given an aging population, and better urban management outcomes in the North, East and opportunities among ethnic greater female labor force -ARITIES can boost competitiveness and estates can improve human minorities would ensure social participation would be promote shared growth. capital required for enhancing sustainability. important to increase overall competitiveness of these provinces. growth. EVIDENCED-BASED Strong. Very strong. Moderate. Strong. Substantial evidence on the Substantial evidence on high Evidence on lagging human location concentration of poverty poverty and exclusion in the North, development outcomes of some around urban agglomerations, as East, Moneragala and estates, minorities, and also international well as potential for enhancing across multiple indicators. evidence on need to address growth in urban corridors. post-conflict needs to prevent return to conflict. ESSENTIAL Yes Yes Yes Yes PRE-CONDITION Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 147 4. GOVERNANCE Key Priorities on Improve the regulatory environment to allow Review the regulatory role and participation Improve the efficiency of the public sector Governance firms to grow and enhance overall productivity of the public sector in the economy in the economy IMPACT ON TWIN Providing a more conducive business climate Reducing the distortionary impact of the state’s Improving controls on public sector GOALS with business-friendly regulatory systems would role in the economy can ensure private sector is remuneration and reducing political influence allow formal firms to grow and reduce informality, not crowded out and can grow, generating more in public service management could improve thereby creating more and better jobs. and better jobs for the bottom 40 percent. service delivery, with particular impacts on lagging regions. Land management could allow for better use of agricultural lands, and greater certainty over property rights could induce greater investment and job creation. TIME HORIZON Medium-to Long-term Medium-term Medium-to Long-term: Medium term: trade facilitation; Gains from improvements to public sector Long term: Labor legislation efficiency and better service delivery to people Land management will be seen in the medium and long term. COMPLEMENTARITIES Removing regulatory obstacles will amplify the Better management and reduced budgetary Increased efficiency of the public sector will gains from greater innovation and from greater burden of SOEs can free up resources for help address the fiscal challenge. Freed up trade openness, by enhancing competitiveness increasing social spending. resources for new investments in human and growth of the private sector. capital as well as meeting infrastructure needs of a middle-income country. EVIDENCED-BASED Strong. Moderate Strong Substantial evidence on the low performance Loss-making SOEs are a substantial drag on Several detailed analyses of shortcomings on ease of doing business, regulatory barriers public finances. in public financial management, particularly faced by firms, and high and growing informality procurement and Sri Lanka has been an outlier Large public-sector employment that is among firms. in terms of accountability and transparency generously remunerated poses unfair of public sector operations. High opportunity competition to private sector businesses wishing costs of large, inefficient public sector. to find and retain the best possible candidates. ESSENTIAL PRE- Yes No Yes CONDITION 148 5. SUSTAINABILITY Key Priorities on Sustaining peace and Developing a more Placing heavier emphasis Preserve natural assets Addressing long-term fiscal Sustainability security through long accountable and on direct investment and and address the impact of sustainability concerns term reconciliation efforts effective state equity portfolio flows climate change related to population aging than debt IMPACT ON TWIN As a country with a Governance reforms that Reliance on debt to finance Tackling environmental Without a robust and well- GOALS history of violent conflict, improve accountability growth constrains the challenges will reduce financed pension scheme, long-term reconciliation to citizen’s can improve available public finances vulnerability of communities Sri Lanka would leave older among the country’s efficacy of state programs to meet social needs and at most risk of droughts, populations in poorer groups ethnic communities, and in meeting the twin tackle extreme poverty as sea level rise, crop loss and more vulnerable. Lack of preventing new fissures goals. Recent governance more money is utilized on agricultural land degradation, fiscal space to support along religious lines from reforms must be seen debt repayment. Attracting water pollution, landslides healthcare and elderly emerging, are essentially as a beginning in a FDI will contribute to growth due to deforestation, etc. care needs would also hurt for creating a climate of wider effort to improve of the private sector and Environmental management inclusion and reverse gains inclusivity and promoting effectiveness and create jobs for the bottom will also influence poverty in made on reducing poverty. shared prosperity. accountability of the 40 percent. urban areas. state. TIME HORIZON Medium- to long-term Medium- to long-term Medium- to long-term Long-term Long-term COMPLEMENT Forging a sustainable A more accountable Enhancing FDI and Preserving Sri Lanka’s natural Decreasing tax revenues due political settlement to long- and effective state can equity flows can improve assets and environmental to a smaller working age -ARITIES standing fissures along ensure better utilization competitiveness with quality will have a positive population would further ethnic and religious lines of public finances and expanding productive spillover effect on improving constrain public finances. can improve inclusion, greater transparency and capacity, opening to new competitiveness in economic Sustainable financing for improve competitiveness better governance can markets, job creation, and sectors that rely on them, such pensions would help ease of the economy, and make provide a more conducive technology transfer. as, tourism and agriculture. the fiscal burden brought on Sri Lanka an attractive environment for private by an ageing population. investment destination. sector activity. EVIDENCED-BASED Strong. Moderate Strong Moderate Strong Substantial evidence on Substantial international the impact of conflict evidence on the risks of on growth and human reliance on external debt development outcomes. financing. International evidence on risks of returning to conflict. ESSENTIAL Yes Yes Yes Yes No PRE-CONDITION Notes: Short-term defined as 1-2 years; Medium-term as 3-5 years; Long-term as more than 5 years. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 149 APPENDIX 2.1 INFRASTRUCTURE Figure A3 Access to infrastructure 100 90 India 80 70 South Asia 60 50 Thailand 40 30 Vietnam 20 Lower middle 10 income 0 Sri Lanka Access to Improved Improved water Roads, paved (% electricity (% of sanitation facilities source (% of of total roads) population) (% of population population with with access) access) Source: World Development Indicators, 2012; note roads percentage for Sri Lanka is 2003 Sri Lanka has taken significant strides in recent years to upgrade the amount and accessibility of infrastructure. Whereas South Asian comparators continue to have infrastructure gaps that profoundly limit access for large segments of the population, Sri Lanka has a solid infrastructure base (Figures A3 and A4). Going forward, the main issues for Sri Lanka’s infrastructure development lie primarily in terms of efficiency of operations and maintenance and the lack of an effective framework for soliciting private investment or more generally setting up public-private partnerships. Infrastructure has largely been financed by the budget, with the exception of some independent power generation plants and telecommu- nications networks. Access issues according to 2012/13 HIES data are concentrated in conflict-affected areas in the North, though there has been visible improvement in that region. The government has invested over 220 billion rupees, or about 4.4 percent of its total expenditures (outside of interest payments) in infrastructure in the Northern Province alone over the past five years (Ministry of Finance 2014). Nearly all households have regular access to electricity and power supply is expected to keep pace with an annual increase in demand of close to 10 percent, though this increase will need to be balanced to minimize environmental impacts. Thanks in part to increased private-sector participation, there have been strong gains in recent years in reliability and accessibility of electricity (Figure A5). Recently added capacity has yielded a 94 percent electrification rate according to the Ceylon Electricity Board (CEB). HIES data for 2012/13 shows 96.6 percent of the population in general (94.2 percent for the bottom 40 percent) had access to electricity, with post-conflict areas of Mullaitivu (58.3 percent) and Kilinochchi (40.3 percent). as the major outliers (Figure 29). Of greater issue is the cost of electricity, which appears to be driving the identification of power as a constraint as per the last enterprise survey in 2011, though recent tariff reductions of 25 percent have eased this burden. Costs are driven mostly by fuel imports for thermal generation. System losses have gone down from over 20 percent in 2000 to roughly 12 percent in 2011 (World Bank 2013). Notwithstanding this record, there is scope for improving efficiency in the power sector through optimizing dispatch from generation plants into the grid. Thanks to tariff reforms and a write-down of liabilities, the state-run CEB turned a net profit in 2013. Future demand for energy is expected to be met almost entirely from coal-fired plants with a reduction in the use of fuel oil and hydropower staying level at around 4000 GWh per year and renewable sources modestly increasing from their current levels (Figure 30). How- 150 ever, there is substantial potential and political Figure A4 Assessment of overall infrastructure by firms willingness to develop the renewable energy sector through significant public and private investments with the aim to source a large 6 share of the country’s future energy demand 5.5 from renewable sources, focusing on wind, hy- 5 Sri Lanka dro and pumps-storage. 4.5 Thailand Transport infrastructure has also been en- 4 Vietnam hanced in recent years. Roads now account for 95 percent of passenger travel and 98 3.5 India percent of freight transport. Sri Lanka has a 3 Malaysia high density of roads providing for good acces- 2.5 Pakistan sibility to the population. Expanded efforts to devote more resources to rehabilitation have 2 improved the condition of the overall network, 2009-10 2010-11 2011-12 2013-14 2014-15 though maintenance remains a primary con- Note: Data based on an opinion survey of business executives. Scale ranges from 1 to 7, where 7 cern. Increasing congestion in urban areas is a is the best growing issue owing to an expected doubling Source: World Economic Forum Global Competitiveness Index in modal share of private vehicles from 2010 to 2030 coupled with limitations on available road space as well as poor condition of public transport. Sri Lanka has built expressways connecting the Southern and Western Provinces and has plans to build an expressway network connecting the rest of the island. Capital expenditure on roads has been financed through foreign borrowing (over half of which is from the Chinese Government) and government resources; private financing is expected to be sought for construction of the Northern Expressway. The major issues facing the roads sector are deferring maintenance in a tight budget environment, contracting issues, and attracting private-sector financ- ing. A 2013 report found in a sample of road rehabilitation contracts variations resulting in cost elevation from 38 percent to 53 percent and contract time extensions from the initial period up to completion from 7.5 percent to 180 percent (World Bank 2013). In addition, there are multiple cases of contracting without competitive selection, often owing to financing conditions from external lenders. Figure A5 Electricity generation of grid power plants, 1976-2012 New renewable Thermal Thermal (oil) (coal) Major Hydropower Source: Sri Lanka Sustainable Energy Authority Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 151 Port capacity has been increased substantially in the Figure A6 Share of households with access to electricity past five years. The expansion of the Colombo port in- creased capacity by 50 percent, including a recently com- 100 pleted new terminal under a build-operate-transfer ar- rangement and the construction of a deep draft port in 80 Hambanthota. Colombo is currently the 27th busiest port in the world, handling about one-third as many containers 60 as Dubai and one-sixth as many containers as Singapore in 2013 (Containerization International Yearbook 2013). 40 Sri Lanka has had rapid growth in telecommunications infrastructure, making it a leader in the South Asia in 20 Internet use and broadband take-up. At the same time, Sri Lanka still lags behind many MIC competitors in use of 0 a ar ivu iya l ICT. Internet penetration stands at nearly 22 percent, the ffn na i n ch ait an n Ja tio ch vu ul l M highest among large SAR countries, but lower than MIC Na i no Va M Kil competitors in Southeast Asia, such as Thailand or Vietnam. Similarly, mobile telephony penetration rate is 95.5 percent, Overall Bottom 40% which is higher than the rest of larger SAR countries, but Source: Own estimates, HIES 2012/13. lower than other MICs or the Asia Pacific region as a whole, which is 120.3 percent (Figure A8). Third-generation (3G) services as a percentage of the entire mobile market is 4.4 percent compared to 41.2 percent in the Asia Pacific region. The mobile telephony market has five major companies of which two are dominant. Competition has led to some of the lowest data and voice rates in the world. However, the dynamics in Sri Lanka’s market are such that there is limited incentive for players to invest in increased broadband services in rural areas and new services, which in turn may delay the introduction of new, innovative services in the sector. Despite concerns regarding broadband quality and cost, IT-enabled services and the software industry have grown rapidly in recent years, now accounting for $500 million in export receipts and around 70,000 employed. Despite this success, there remains a workforce deficit in the ICT industry. Figure A7 Projected growth of electricity generation, 2013-2032 40000 Oil 35000 30000 Coal 25000 Energy (GWh) 20000 NCRE 15000 10000 New Major Hydro 5000 0 Existing Major Hydro 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 Source:Sri Lanka Sustainable Energy Authority 152 While sector liberalization has supported Figure A8 Mobile telephony and internet penetration the expansion of mobile services across the country, there are areas where ICT pol- icy and regulation could be strengthened. 140 These areas include enforcing stronger com- pliance to high-quality standards for voice 120 services and data speeds, encouraging faster 100 Mobile penetration broadband roll out in rural areas, and regulat- (as a percentage of ing equal and open access to essential facilities 80 total population) such as submarine landing stations and back- bone networks. Sri Lanka is also one of the few 60 countries in the region that has not leveraged Intenet Penetration telecommunications infrastructure rollout by 40 (as a percentage of other utility providers such as the power trans- total population) mission, railways and roads authorities. An in- 20 frastructure sharing policy would help expand broadband services across the country, lower 0 costs of service provision and provide for do- am ka h d tan es an ia an tn Ind lad mestic network redundancies. kis ail iL Vie Th Pa ng Sr Ba Sri Lanka overall outperforms its South Asian comparators in providing for water Source:World Telecommunication/ICT Development Report, 2014 and sanitation, but there is substantial dif- ferences within the country between urban, rural, and estate sectors. As shown in Figure 26, Sri Lanka has slightly better indicators than South Asian peers and is comparable to LMICs in East Asia. Pipe borne water supply coverage stands at 44 percent (2013, National Water Supply Drainage Board (NWSDB)) nationally; of which 34 percent is managed by the NWSDB and the rest are mainly community managed Rural Water Supply (RWS) schemes or schemes managed by the local authorities. The technical capacity for the operation and maintenance of an estimated 40 percent of the over 4,000 RWS schemes in the country remains low, prompting the government to establish a new National Community Water Supply De- partment in the past year. Approximately 75 percent of the urban population has access to pipe borne water while around 20 percent of the rural population has such access. The quality of service is also lower for communities in small towns and rural areas, where continuous 24-hour supply is a rarity. The water and sanitation service levels in the plantations (estate sector) remain far below the national average, with only sporadic investments having been made in these areas over the past few decades. Yet overall access to safe drinking water, which includes protected wells, is high and reported to be 85 percent of the total population (NWSDB 2013) and 94 percent according to WHO/UNICEF Joint Monitoring Programme (JMP) figures of 2012 for water and sanitation released in 2014. Similarly, the NWSDB estimates that 85.7 percent of the population has access to adequate sanitation; with 83.2 percent having onsite sanitation and 2.5 percent a piped system. The 2012/13 HIES data point to lower levels of access to water (62.2 percent of all households and 55.2 percent of the bot- tom 40 percent) and sanitation (47 percent of the overall population and 36.2 percent of the bottom 40 percent having a toilet on premises), with much lower levels of access in the Northern districts of Kilinochchi, Mulaitivuu, and Vavuniya. The discrepancy is due in large part to the HIES not accounting for protected wells and RWS as access to water. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 153 APPENDIX 2.2 OPPORTUNITIES AND OBSTACLES IN ACCESS TO FINANCE Opportunities Obstacles Commercial banks ■■ Financial innovation among commercial banks (which dominate the financial sector in Sri Lanka) has been have limited limited, with lending practices based on collateral and limited interest in development of other credit processes ability and to serve such as cash-flow-based lending and financial instruments beyond loans. Anecdotal evidence suggests that lack MSMEs. of competition (in spite of a large number of banks in the sector) has reduced incentives for innovation to target underserved economic segments. ■■ Despite the high penetration of regulated financial institutions in Sri Lanka, an estimated 64 percent of micro, small and medium enterprises (MSMEs) remain without checking or savings accounts (World Bank, 2014e), highlighting the need for both higher bank penetration, as well as opportunities for complementary non-bank financial institutions to target underserved market segments. Credit infrastructure ■■ Credit bureau covers 44.5 percent of the population, and 30 percent of registered firms1. However important deficiencies limit sources of information on creditworthiness, such as payment history with microfinance institutions and utilities, the ability of are not included in the information. lenders to identify ■■ Movable collateral registries do not exist in Sri Lanka. This severely curtails the ability of firms and entrepreneurs creditworthy to use non-real estate assets (eg. vehicles, machinery, inventory, accounts receivable) as security to their loans. borrowers. This, together with the bank practices based on collateralization lead to major de-facto obstacles to borrowers, especially smaller ones, which account for 93 percent2 of the enterprise sector. Legal framework ■■ Banks experience significant difficulties in case of borrowers’ default. Despite the existence of a separate deficiencies Commercial Court, resolution of legal disputes takes on average 44 months, creates costs of more than 20 enhance lenders’ percent of the disputed value and requires more than 40 individual steps. Moreover, anecdotal evidence risk aversion, suggests significant discretion in the application of laws resulting in unpredictability of judiciary processes. increase cost of These deficiencies enhance banks’ risk aversion, which limits incentives to expand the borrower base, and credit and reduce fosters increasing collateralization requirements. The high cost of disputes resolution is passed on to borrowers availability of as a higher cost of credit. finance. ■■ The existing Secured Transactions law in the country does not support the operationalization of the collateral registry in an enforceable manner. Limited ■■ Factoring can enhance the ability of MSMEs to obtain financing for working capital by leveraging their otherwise development idle accounts receivable. However, shortcomings in secured transactions framework hamper the viability of of financial factoring as a financial product. instruments ■■ Operational leasing of equipment (an alternative to longer-term bank loans) has been hampered by deficiencies beyond traditional in secured transactions (see above) and the lack of a well-functioning movable collateral registry. bank loans leaves ■■ Microfinance Institutions (MFIs) can be an important source of financing for micro entrepreneurs, especially in important sectors rural areas. However, the lack of regulation and supervision of the MFI sector has led to a proliferation of lenders and financial (estimated at more than 1,000) with anecdotal evidence of abuses on pricing and loan recovery practices. The services needs lack of regulation of deposit-taking MFIs also creates significant risks for savers. underserved. ■■ Insurance is significantly underdeveloped for an economy with the income and aspirations of Sri Lanka, leaving enterprises and individuals vulnerable to unforeseen events. Less than less than 15 percent of SMEs and less than 1 percent of micro enterprises used any form of insurance. Personal insurance premiums account for 1.22 percent of GDP, well below the proportion in India, Malaysia and Thailand (4.10 percent, 4.92 percent and 4.07 percent, respectively). 154 Lack of consumer ■■ Lack of a well-defined consumer protection framework (including appointment and empowerment of an agency protection, in charge of its enforcement) leave users of financial services unprotected against unfair practices by lenders. financial literacy, ■■ Lack of financial literacy initiatives and business development services, especially targeting micro entrepreneurs and business and low-income individuals in urban and rural areas enhance the risk of over-indebtedness. development services expose the population to significant risks. Lack of financial ■■ Remittances represented about 10 percent of GDP and 86 percent of reserves in 20143. But Sri Lanka has not innovation around leveraged fully the potential of remittances due to factors including: remittances -- High cost of formal channels with an average fee for remittances of more than 10 percent of the principal. restricts their This discourages the use of formal channels in favor of informal mechanisms, thereby limiting the flow and potential permanency within the financial sector. mobilization for -- Use of innovative cross-border money-transfer technologies through mobile phone platforms has not investment. been developed in Sri Lanka, while it has proved a way to enhance accessibility and affordability of formal remittance channels in other countries in the region -- Financial Innovation leveraging remittances flows has not taken place in Sri Lanka, while in other countries this has led to investment instruments linked to remittances including housing and larger investments (diaspora bonds). 1  Doing Business 2015 2  Statistics Committee and IFC estimations. 3  Source: Central Bank of Sri Lanka. Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 155 MAP OF SRI LANKA 156 Sri Lanka — Ending Poverty and Promoting Shared Prosperity | 157 158